Advantages of Trading Stocks

Mention “stock trading” and chances are you’ll think of a stock exchange, with endless rows of numbers flashing red or green, and people scurrying around in the background. It’s quite a disorienting scene, to be sure, and it is undeniable there is a wealth of information and knowledge that goes into being an experienced stock trader.  

But here’s the truth: trading stocks isn’t just for financial experts –anyone can learn how to do it. The key lies in learning about what stocks are, how they work, and the work, and knowing the basic principles to observe when trading stocks. And that’s just what we’ll be discussing in this article, so let’s get to it!   

Key Points 

• Trading stocks offers diverse strategies and opportunities, from short-term day trading to long-term investing, catering to different risk appetites and goals. 

• Stock trading allows for portfolio diversification and exposure to both domestic and international markets, helping manage risk and capitalise on global opportunities. 

• Liquidity and accessibility of stocks make them an attractive investment, with online platforms enabling traders to enter and exit positions quickly and easily. 

What are stocks? ^[1]  

Stocks, also known as shares, represent a stake of ownership in a company. They are issued by companies as a means to raise capital from the public in order to fund business activities, expand operations, invest in new products and services, or for any needed purpose.  

Those who own stocks are known as shareholders. They are entitled to the company’s profits and assets, in proportion to the number of shares they own. This means that the more shares you own, the larger your share of the profits will be.  

Stocks give shareholders the right to vote on certain decisions that impact the company; in this way, exerting a degree of control over the direction and fate of the company. Shareholder rights vary among companies and may include:  

• The right to vote on the board of directors 

• Operational or structural changes that may alter the company’s commercial focus and aims 

• Matters that directly affect stock ownership (such as stock splits) 

• Mergers and acquisitions 

• Compensation packages for executives. 

What gives stocks their value? 

Stocks are an important determinant of the value of a company; the stock price, multiplied by the number of outstanding shares, gives the market capitalisation of the company. When someone says “Apple Inc. is the largest company in the smartphone industry,” they are referring to Apple’s market capitalisation, and not the size of its workforce, or the floor area of its offices.  

But what determines the price of a stock in the first place, and what causes stock prices to rise or fall? 

In short, the price of a stock is derived by market demand. Stocks are securities that can be traded freely on the stock exchange, and the price of the stock is set by buyers and sellers. If demand for a stock increases, investors are willing to pay more to own shares of the stock, bidding the price up. The opposite happens when demand for the stock falls. To better understand how this dynamic works, dive deeper into the concept of supply and demand by reading our article, ‘A Complete Guide to Supply and Demand: How to Use It Effectively.’ 

Here are some common factors that impact demand for a stock: 

Company performance 

If the company fails to meet key targets such as revenue growth, or cost reduction, investors may seek to sell their stocks, causing the price to go down. Conversely, strong earnings and other markers of good performance can raise demand for the stock, fostering a rise in stock price.  

Scandal or negative news 

A food company found responsible for food safety issues may see consumers avoiding their products. This can impact sales and lower revenue, eroding investor confidence. In fact, just the mere news of a scandal can cause investors to start dumping their stocks in anticipation of public backlash, triggering the drop in stock prices they were trying to get ahead of. 

Geopolitical and macroeconomic instability ^[2] 

Destabilising events such as a pandemic, war or economic sanctions can impact the stock price of affected companies. Consider Peloton, an American company which specialises in home workout machines.  

When lockdowns were in effect, demand for Peloton products skyrocketed as Americans sought an alternative to going to the gym. Revenue quadrupled to USD 4 billion and the company’s stock price rose a staggering 760% between mid-March 2020 and mid-January 2021. However, once lockdowns were lifted and people could start going out to exercise, Peloton’s stock price fell by 80%. 

Why trade stocks? ^[3]   

As discussed, the value of a stock is influenced by various factors, including the company’s financial performance, industry trends, and overall market conditions. This means that the prices of different stocks can fluctuate, potentially creating opportunities for investors and traders to generate profits.  

When a stock’s price rises, you can sell the stock for a higher price than what you paid for. You can pocket the difference as a profit, minus fees.  

When a stock price falls, you can also potentially profit from it, through what’s known as short-selling. This is a more advanced strategy where a trader first “borrows” the stock they want to short, and sells them at the current price.  

When the price falls, the trader buys the stock from the market at the lower price to return what was borrowed. The difference in both prices make up the profit (less fees) for the short-seller.  

While some stock traders prefer to buy and sell stocks frequently to capture profits from price fluctuations, others may choose to simply purchase and hold stocks and wait for them to rise in value. This is typically a long-term event lasting several years.  

A variation of this buy-and-hold strategy focuses on dividend stocks. These are company stocks that distribute profits to shareholders via regular payouts called dividends. A portfolio of dividend stocks from established companies can potentially generate a steady stream of passive income, contributing to long-term wealth accumulation. 

Advantages of trading stocks   

1. Diversification   

With the diverse selection of company stocks across different industries, sectors and even geographical regions, stock traders spread their investments across different companies and sectors for portfolio diversification. This is a popular risk-hedging technique that hinges on avoiding overdependence on a single stock or industry, and instead maintaining holdings with low correlations to smoothen out market volatility.  

As an example, growth stocks tend to do well when there is strong economic growth, but falter during market downturn. Defensive stocks (basically, consumer essentials such as food, household products, etc) ,tend to be more stable throughout market cycles, and the presence of some can help to prop up a growth stock portfolio during market pullbacks.  

Interested in learning more about profile diversification? Read our article on profile diversification here.  

2. Flexibility in strategies  

A foremost reason for the popularity of stock trading is the ability to choose a wide range of strategies to accommodate different risk appetites and trading goals. Whether you’re looking for potential short-term returns through day trading, potential steady growth with long-term trading, or a combination of both with swing trading, stock trading provides multiple ways to tailor your trading to your preferences.   

3. Liquidity and accessibility  

Stocks are highly liquid assets, meaning you can quickly sell your holdings and convert them into cash. This liquidity provides traders with the flexibility to enter and exit positions promptly.  

Furthermore, trading stocks has become more accessible with online platforms, allowing traders to trade their favourite stocks from anywhere with an internet connection, or react quickly to breaking news and developments.  

4. Exposure to international markets  

Trading stocks is one of the most convenient and cost-effective ways to participate in the economies of foreign geographical regions. Instead of choosing from their own local companies, stock traders are free to buy and sell stocks of companies in other countries, including those with larger and more vibrant economies. 

Additionally, stock traders can also hedge their risk by diversifying across different geographical regions, potentially finding opportunities in less well-known stocks, such as those of emerging economies.  

What should you know before trading stocks  

Before you dive in and make your first stock trade, there are several important points to take note of. Keep these tips in mind as you embark on your journey as a stock trader.

Educate yourself 

It is imperative to educate yourself on what stocks are and how the stock market works. While we’ve covered some basics in this article, know that there is much more to learn. Browse our collection of articles, courses and other resources and start building your knowledge.  

Set a realistic budget  

Set aside a budget for trading, one that is realistic and reasonable for your current financial situation. Only trade with money you can afford to lose, and once your trading budget is used up for the week or month, stop trading instead of digging further into your savings.  

Importantly, never take a loan just to trade. It is unlikely that as a beginner, you will be able to generate enough returns to repay your loan with interest, and still potentially making a profit.  

Arm yourself with research   

As we’ve discussed, there are many factors that impact a stock’s price. Thus, it is critical to research as much as you can into the companies you are interested in trading.  

Focus on both internal factors (company performance, news and developments, future plans, etc.,) as well as external factors (macroeconomic risks, geopolitical events, changes in policies and regulations, etc.,). Always strive to keep up with the latest news and analyses from reputable sources and analysts you trust.  

Know your risk appetite 

Trading can be volatile. It is important to determine your risk tolerance and how comfortable you are with losses. Be mentally prepared and avoid letting emotions affect your decision-making, leading to bad trades.    

Choose your preferred trading goals & strategy  

Work out a clear trading strategy that aligns with your goals and preferences. Lay out your aims and outcomes, and decide beforehand what actions you will take when certain thresholds are reached.  

Trading can be emotionally challenging, but sticking to your trading strategy can help you avoid impulsive decisions.  

Trading stocks CFD with Vantage  

Having a reliable broker is crucial in stock trading. A top-rated broker provides comprehensive research tools and educational resources, helping you to make well-informed decisions.  

If you’re searching for a reputable broker, Vantage is your answer. Vantage is a global, multi-asset CFD broker that offers services for trading CFDs on Forex, Commodities, Shares, and Indices. Sign up for a Vantage live account here and start trading stocks through CFDs today.

References