What Are Stocks and How to invest in Them

Written by: Richard Sine Edited by: Adrian Ashley Fact Checked by: Bahaa Khateeb

12.04.2024

Stock trading is a good way to go if you are looking for a compelling financial asset to trade in today's retail marketplace. Most brokers support stock trading, and there is a thriving global marketplace made up of several well-known indices from which you may choose.

Stocks can be a powerful option to trade due to their potential for long-term growth. Stocks are known to offer consistently higher returns over time than other investment options, such as bonds or savings accounts. Indices are also highly liquid, meaning you can easily buy and sell on stock markets all over the world, and you can convert your holdings into cash when needed.

Stocks are flexible instruments that allow you to open and close positions at any time and use them in conjunction with a variety of trading strategies, such as scalping, day trading or swing trading. If you are looking for a flexible, accessible and cost-effective way to trade a range of different indices, stocks may be right for you. In the remainder of the article, we will describe what stocks are and how you can trade them.

What are Stocks?

If you own stocks, you have ownership in a publicly traded company. When you buy a stock, also known as a share or equity, you are really buying a small piece of the company in which you are investing. With publicly traded companies, the gross value of a company's stock is divided into shares, and each share represents a portion of the company's assets.

When a company issues new stock, as it can do frequently, it uses the money it earns to fund its operations, capitalize new projects or dish out dividends to shareholders. Shareholders, like retail investors, can also profit from the growth of a stock's value over time or receive payment in the form of dividends.

Stocks are traded on exchanges where buyers and sellers congregate to trade shares. The value of a share is determined in large part by supply and demand in the market, with investors constantly negotiating prices based on such factors as the company's financial performance, industry trends and economic news. There are several prominent stock indices in the world, some of which include:

S&P 500: This index is based on the market capitalization of 500 of the largest companies listed on the US stock exchange.
Dow Jones Industrial Average (DJIA): This index is based on the performance of 30 blue-chip industrial and manufacturing companies in the US.
NASDAQ Composite: This index measures the performance of over 3,000 companies listed on the NASDAQ stock exchange.
FTSE 100: This index represents the 100 largest and most prestigious companies listed on the London Stock Exchange in the UK.
Nikkei 225: This index is based on the performance of 225 high-quality companies listed on the Tokyo Stock Exchange in Japan.
Shanghai Composite: This index monitors the performance of all A-shares and B-shares listed on the Shanghai Stock Exchange in China.
Euro Stoxx 50: This index represents the performance of 50 blue-chip companies from Eurozone countries.

These indices are closely followed and heavily traded by retail investors. They are often used as benchmarks to verify the performance of different markets or investment portfolios.

Do You Need a Broker to Trade Stocks?

It is not mandatory to use a broker. You can handle your purchases on your own. In that case, there is no need to hire a conventional stockbroker. This type of investing is called direct-access trading. However, most traders find it worth the time and effort to use a broker as it is also just more practical. This is because brokers are experts in the field who can offer guidance and advice and can shorten the learning curve of trading stocks. The truth is that trading stocks on your own can be tricky, especially if you are a newbie. This technical and complex field often calls for a broker.

If you are new to the game, you will find a lot of use for an online stock broker. A well-constructed stock broker Website and trading platform can help you with research and data analysis, which in turn helps you make quicker and more data-rich decisions.

Regulations Around Stock Trading

Stock trading is a long-established practice that is legal in all major markets. One notable exception for Sharia traders is that they are not allowed to purchase the shares of companies that engage in haram activities, such as alcohol production or gambling.

As far as regulation goes, all brokers must be regulated by a major oversight body. Some common regulators include the Financial Conduct Authority (FCA) in the UK, while in Cyprus, brokers are regulated by the Cyprus Securities and Exchange Commission (CySEC). Australia has the Australian Securities and Investments Commission (ASIC) and US brokers are under the control of the Securities and Exchange Commission (SEC).

Regulators perform many functions. However, the most important ones relate to making sure that brokers in their jurisdiction are registered and abide by a set of operating rules and norms. Some regulators also have disciplinary powers over regulated entities and persons associated with them. These regulators often require periodic reporting of information by companies with publicly traded securities. The oversight provided by regulators means it is always the best advice to choose a broker that is regulated by a top-tier watchdog.

What are the Risks of Stock Trading?

Stock trading may be a lucrative pursuit, but it is not free of risk. Some of the main dangers of stock trading include:

Market volatility: Share prices often shift rapidly in light of breaking news or market developments. If traders do not watch their positions closely, they can suffer significant losses. Alternatively, they could also benefit from serious gains.

Company performance: Management changes, product failures, or regulatory changes: each of these factors can result in a decline in the value of the stock.

Liquidity risk: Even though stocks are mostly liquid, there may be times when a stock is hard to sell due to low trading volumes or market conditions, especially when the stock market is spooked and there are few buyers.

Currency and exchange-rate risk: If you invest in stocks that are traded in a foreign currency, you may be exposed to fluctuations in exchange rates, which can affect the value of your investment.

Inflation risk: As we are seeing in present economic conditions, inflation can quickly erode the value of your investment over time, meaning that the purchasing power of your returns may be limited.

Regulatory risk: Stocks are highly regulated in some countries, as we have shown. There is a risk to companies getting things wrong and being punished by a regulator.

Stock trading has its risks and must be approached with careful risk-management strategies and mastery of the markets. Traders must not invest more than they can afford to lose and they should at all times know the dangers involved before engaging in this type of trading.

The Pros and Cons of Stock Trading

Here are some potential pros and cons of stock trading:

Pros:

You can make good money: Stocks can provide the upside of high returns, particularly over the long term. Historically, stocks have offered higher returns than other investment options. The caveat is that you must manage your stock portfolio well.

Diversification: This is one of the mantras of the trading world – diversify! Every expert will tell you it is better to have a wide range of financial assets and trading strategies in your portfolio so you can protect yourself from losing money when one type of trading fails you. With stocks, you can diversify by investing in many different companies from different indices.

Liquidity: Shares are normally highly liquid, meaning they can be easily bought and sold on stock markets, allowing investors to quickly convert their holdings into liquid cash if needed.

Line of sight: Part of being a public company whose stock is traded on an open market is that it must be transparent about its performance. For this reason, publicly traded stocks are subject to regulation and oversight, giving you clear information you need to decide about whether to invest in a firm or not.

Opportunities for active trading: For those who enjoy active trading, like day traders and scalpers, stocks can offer many opportunities for short-term gains through buying and selling based on market fluctuations and breaking news.

Cons:

Markets can be volatile: Stock prices can be highly volatile, meaning that they can fluctuate rapidly and unpredictably in response to a range of factors, such as economic conditions, company news or geopolitical events.

Company risks: Stocks are largely a reflection of how well or badly a company is doing and how investors feel about the prospects of its products and services now and into the future. Thus, share-price performance can be influenced by internal factors, such as management and product updates.

High risks: stock trading comes with no small amount of risk. You are constantly on a high wire balancing the risks posed by high leverage, volatility, and potential losses exceeding the initial investment. For example, Facebook’s parent company in 2022 lost significant share value after announcing its new venture, the Metaverse, as investors were unconvinced by the viability of the idea.

Complexity: Investing in stocks requires you to work on your knowledge and understanding of financial markets. This typically requires time and effort to research companies and stay on top of market news.

No guarantees: Investing in stocks, like any financial instrument, involves risk. No person or institution can guarantee that you will make a profit. Stock prices can also drop quickly, sometimes causing significant losses for investors.

These benefits and drawbacks do not apply exactly equally to all investors. The risks will vary depending on an individual's financial goals, risk tolerance and investment strategy. As with any investment, it's important to do your research, diversify your portfolio and research the field as much as you can.

What are the Best Strategies for Trading Stocks?

Every trader’s stock strategy is different. That said, here are the most popular trading styles that are commonly used in stock trading:

Scalping: With scalping, you hold positions open for a brief time, as little as a few seconds to a few minutes. The intention is to profit from fractionally small price movements.

Trend-following: With this strategy, traders identify trends in the market and try to understand the direction of the trend. Using technical indicators, like moving averages, trendlines or relative strength index (RSI), you can make money from trends.

Breakout: Skilled traders can come to understand when asset prices break through key support (lower) or resistance (upper) levels. Using common technical indicators, such as Bollinger Bands, traders can identify breakouts to help them set trades.

Swing trading: If you prefer a gentler trading pace, swing trading could be for you. With this type of trading, you would hold an asset for a few days to several weeks, depending on the strength of the trend.

News trading: The world is awash with news alerts and breaking market information. Some sensitive financial assets, such as cryptocurrencies, typically respond to good or bad market news. If you learn how to craft a winning strategy around economic releases, company earnings or geopolitical events, you could do well with this type of trading.

It is vital to select a strategy that suits your trading style, risk tolerance and market conditions. You must have a clear understanding of entry and exit points, risk management, and position sizing before you start to trade.

Recommended Brokers

Active Trading Vs. Day Trading

Active traders are investors who carry out 10 or more trades per month. Active traders rely on the timing of the market, taking advantage of news events to make a profit. Day trading is conducted by investors who make a lot of small trades daily with the aim of making small amounts of profit many times over.

Day trading was first popularized by human stockbrokers who operated from the trading floors of the world’s best-known indices. Before technological advancements allowed a wave of retail investors to join the trading movement while operating from home, stockbrokers would compete fiercely to buy and sell assets on behalf of their clients in a brick-and-mortar commodities or stock-exchange building. Most of these trades were opened and closed within the same daily trading session, hence the name “day trading.”

Therefore, day trading, even though it is now performed digitally, is a style of trading where traders buy and sell assets within the same trading day. Why is this noteworthy? Well, since some types of trading take place over days, months and even years, it is worth making the distinction that some types of trade happen within a day.

With day trading, the idea is to make use of price fluctuations or gaps in the market to make many small profits that accumulate due to the sheer number of orders the trader makes. This form of trading, sometimes also called “intraday trading,” requires a powerful online broker that can facilitate rapid execution with very few service failures. However, there is a downside to day trading, given the proliferation of investors who have entered the market with the intention of using this sometimes-controversial trading style to soak up liquidity and compromise the execution speed of slower investment styles. Some brokerage firms have limited or even banned day trading.

What Features Should a Good Stock Broker Offer?

When choosing a broker for online stock trading, there are several elements to consider. What are the broker’s educational offerings – such as articles, videos and Webinars? Intermediate and advanced traders will want a robust trading platform and a full suite of options-specific trading tools and resources. What is the quality of the mobile app? All these elements must be considered beyond the usual items that set online brokers apart from each other, like fees, trading platform strength, security and speed of trade execution.

Trading stocks safely and reliably depends on the platform you use. Make sure that your chosen broker has all the functions you are seeking. There is a lot of difference in quality between the best exchanges and the worst. Here is more information on the main elements you need to consider when choosing an online stock broker:

Stock Fees

In such a competitive environment, trading fees have fallen drastically over time. However, it is still possible to find a lot of variability among fee levels at different brokers. Most modern brokers have slashed their trading commissions on stocks and ETFs to $0. As a new trader, be sure to keep your eye on fee levels.

Non-Trading Fees

You will run into fees at selected brokers even if you don't trade. A typical instance is when your account has been inactive. These so-called inactivity fees can start to bite if you have not chosen your broker well.

Broker Resources

When you conduct a holistic assessment of your broker’s strengths and weaknesses, it is important to note important additional tools, like education and research tools. Also, look out for the quality of important elements, like the trading platform as well as its safety and speed.

Available Stock Assets

The best stock brokers should provide you with a wide range of stock exchanges on which to trade. The quality and variety of these exchanges are important as many traders take a global approach and require access to bourses around the globe.

Features of the Best Trading Platforms

The best brokerage accounts for stocks should offer excellent trading platforms, educational resources, breaking news services and more. Taking into account what makes some brokers stand out from others, here are some of the features we looked at when deciding which online stock brokers were the best in the market:

Commissions and Fees

In this ultra-competitive and price-sensitive market, online stock and ETF trades should be free. It is an industry norm for investors to pay $0 commissions at most online stock brokers, and some even offer options trading free of charge, which is great news for active traders. You are advised to compare rate cards carefully as there is a wide range of fee structures between brokers.

Mutual Funds

In our research, we found that the majority of brokers charge a commission for mutual fund trading. However, that is not the end of it, as there are many hundreds of funds that trade with no commissions at all. You should carry out thorough research to understand what is on offer.

ETF Investing

Many stock brokers who offer ETF trading provide $0 online commissions for ETF investing, but they also offer low-cost ETFs. These types of ETFs are selected and managed by internal analysis teams at the stock broker and could give you good value if you spend time understanding them.

Options Investing

A well-rounded stock brokerage account will not only offer access to investing in stocks, ETFs and mutual funds, but also options. The top options trading platforms tend to include $0 commissions for online options trades and high-quality trading software across online, desktop and mobile devices.

Account Minimums

For a newbie trader with limited capital, it can be very attractive to work with a broker who does not have account minimums. Most online stock brokers don't stipulate account minimums, but some do. You should make sure you are comfortable with the minimums if you work with such a broker.

Trading Platform

The best trading platforms have basic and advanced features that will suit beginner and elite traders alike. It should be clear that the broker has spent a great deal of time and effort creating a platform with useful functionality. This could be smart tools like internal analysis, complemented by Expert Adviser (EA) assistance. The more the platform is loaded with extended features and helpful tools, the better.

Research

The broker should have taken time to create a strong research product that, among other things, gives you the latest trading news from key markets. It could provide articles that discuss important matters, like inflation. Many brokers take time to invest in market summary information and a detailed economic calendar.

Products

The quality and variety of products are important. How many stocks do they offer? The best online brokers offer you the chance to buy stocks from dozens of countries. As a rule of thumb, the broader the market access, the more serious the online broker is about exposing you to the world of online stock trading.

User Experience

Traders can easily get a sense if they are in good hands. It starts with the broker’s Website, its functionality and the user experience. When you start trading, the process should be intuitive and free of glitches. In such a fast-paced environment, such as day trading in stocks, you don’t want technical issues slowing you.

Transparency

The best brokers are honest about their service offerings. This includes making it easy to find declarations relating to their regulatory status, as well as the ins and outs of their service offering. Some brokers even find a way to make bad news palatable, such as stipulating services they do not offer.

Customer Service

As timing is key to online stock trading, you must pick a brokerage firm that is able to provide good customer support around the clock. This most notably includes the company representatives being easy to reach, fast and polite, which will in turn spare you of having to worry about problems down the road.

How to Start Trading Stocks Quickly

If you are a newbie, it might be daunting to join the dynamic world of trading stocks. It can certainly be dangerous to enter headlong into stock trading without learning the fundamentals. Fortunately, a good online stock broker can provide educational material and tools that will make your journey easier. Normally, this is how your journey will go:

Opening a brokerage account is fast and convenient. Users simply access the broker’s Website and click “Open account.” After reading and accepting all the terms and conditions, traders can move on to choose their account type, show their trading experience and provide the standard documentation required to get approval.

Many brokers offer a demo account. Clients can use these demo accounts to practice their strategies. The demo account normally comes with virtual funds, which should be enough for traders to get acclimated to the broker’s trading ecosystem. From there, you can fund your trading account and get started.

Scams to Watch Out for When Trading Stocks

Most investors trust their account managers to make recommendations that benefit their investment portfolio. However, stock-broker fraud occurs with worrying regularity.

In the US, the Financial Industry Regulatory Authority (FINRA) monitors US broker-dealers and their employees. In 2020, FINRA handled 5,472 complaints from investors, a marked rise from the 2,954 complaints fielded in 2019. At this point, we will remind you that the best way to steer clear of these common scams is to engage with brokers who have a long trading history and who are regulated by top-tier oversight bodies. Some of the most common forms of stockbroker fraud are described below.

Insider Trading

Insider trading is when someone has meaningful or material information about a stock and how it might behave in the future and they pass this on to someone who acts on that information to their own (financial) benefit. One example is if there is a tip-off about a major stock selloff that might cause a major loss of value. If this is acted upon it is considered insider trading.

Theft of Client Funds

This is otherwise known as theft, pure and simple. Whenever a stockbroker steals deposits from clients' funds and places them into their own account, it is a misappropriation of funds. This is one of the oldest types of broker fraud that sees illicit stock brokers take payment from their clients and divert them into their own accounts rather than buying the stocks they have been instructed to buy.

Omitting Key Facts

This happens when stock brokers give you misleading or deceitful information about an investment product. This could be outright lying or omission of crucial facts where brokers “forget” to give you important information. This information is usually relevant to your decision about whether you should invest in a product or not.

Pyramid and Ponzi Schemes

Ponzi schemes are fake investments that can only continue to exist as long as there are funds from new investors to pay fake returns to earlier investors. When there are no more new investors, the scheme falls apart.

Pump-and-Dump Schemes

A “Pump-and-Dump” scheme is when a stock is built up through false claims. Often, the people behind the scheme have already bought it and will post untrue statements about the targeted stock, often on social media, claiming the company is planning to release a development causing the stock price to jump drastically. In response, other individuals take the bait and purchase the stock, causing the price to increase. As soon as that happens, the people behind the stock dump it, leading to the new investors losing money.

Unauthorized Trading

Before an online broker can make trades on your behalf, you must give them permission. There are two main types of investment accounts – non-discretionary and discretionary investment accounts. The former grants you more control over your account as your broker must have written or verbal instructions to act on your behalf before making any trades. The second type of account, a discretionary account, gives your broker more clout as they do not need approval below a certain level to make trades on your behalf.

The Bottom Line

With ever-improving technology, trading stocks online is becoming a much more rewarding activity. Many of the top online brokers are long-established, well-regulated brokers that are always trying to improve their products and the trading experience of their clients. With immersive platforms and commendable amounts of insightful market analysis, clients will find a home with any reputable online broker.

Don’t forget that for all its pros, stock trading does offer some significant cons, such as the ability to lose a lot of money very quickly, as it is a risky exercise. However, if you do your research ahead of time and enter the market with strong risk-management strategies, you have a chance of being successful.

FAQ

Is it best to go with the cheapest stock broker?

Trading costs are important to active traders. However, many brokers now offer commission-free trades of stocks and ETFs. While fees are important, other factors like the broker’s product portfolio and trading platform should also come into your thinking. There is no point selecting a broker on price alone and feeling short-changed by limited functionality.

How can I diversify without much money?

You can develop a diverse portfolio of individual stocks without much upfront money thanks to zero-commission online stock trading and fractional shares. Be sure to check that your broker offers these services as not all brokers do.

How much money do I need to start?

Many broker firms have required minimums linked to the type of investment you make. Most mutual funds have minimum investments of around $1,000, which is not cheap. However, if your broker offers fractional shares, you may be able to get going with as little as $1. It is important to carry out thorough research before you commit to any broker as there are many different account minimum requirements in place among different brokers.

Is my money insured?

This can be the case, but only sometimes. It depends on where your broker is regulated. For example, brokers regulated by the FCA in the UK are protected by mandatory investor fund protection through the Financial Services Compensation Scheme (FSCS). Similarly, American brokerage firms are mandated to become members of the Securities Investor Protection Corporation (SIPC). If you choose a broker from an area with weak regulation, it is likely that you have no fallback if the broker goes bust.

How do I select the right brokerage firm for me?

Some important matters to think about when assessing a potential broker include how much money you have and the type of assets in which you wish to invest. You should also factor in your trading style and what it means for how frequently you will need to trade. Then, you need to consider other items like account minimums, customer service levels, the availability of research materials, and more.

Are earnings from trading stocks taxable?

Yes, earnings from stocks are taxable in the same way that profits from other forms of investing, like FOREX and crypto, attract tax on profits.

How can I start trading quickly?

As soon as you have clicked on the “open account” button on your broker’s Website and you comply with Know Your Customer requirements, your account will be opened, allowing you to make a funds transfer to the brokerage firm. This can take a few days to show up in your broker’s account. Once that is complete, you can start trading.

Written by

Richard Sine

Richard Sine is a long-time technical editor and writer. His credits include a weekly column in the New York Times and a book in the Dummies series. His work in the financial industry includes major U.S. and Canadian banks, as well smaller fintech fi...

Edited by

Adrian Ashley

Adrian Ashley is a seasoned business and finance writer. With a corporate career spanning over 20yea...

Fact Checked by

Bahaa Khateeb

Bahaa Khateeb is currently the CEO of Arincen, a start-up Fintech company based in Haifa. Baha...