When Should You Trade A Stock?
When should you trade a stock is an intriguing question and one often asked by those tentatively starting to trade the markets. However, in reality it’s quite similar to another one we ask ourselves all the time. When should I go to the supermarket or pharmacy or the petrol station? Like any other marketplace, you’re simply trying to find out when’s the best time to go and buy whatever item or commodity you’re in need of?
Just as in the real-world, you’d want to make the purchase when conditions are right for you personally (you are physically and psychologically well) and the items you want are readily available to purchase. You’d also want to buy from a store where prices are stable, I.E they don’t fluctuate unpredictably and you are not being exorbitantly charged. It would also be important to make sure that the taxes and overheads the proprietors pass on to the customer are not too steep. The list goes on but it’s really quite simple.
So, in this example, the factors that should be taken into consideration when deciding the right time to make a purchase are related to (i) the buyer (you), (ii) the store owners (the broker in the context of trading the stock markets), (iii) wider market conditions and (iv) conditions relating to the item of purchase.
The influential things to consider when deciding the right time to trade a stock are broadly similar, though applicable in a slightly different context, so let’s examine these influences on stocks and shares in a bit more detail.
Conditions Relating To The Stock
As with any purchase, you need to do your due diligence by researching the stock you intend to trade in order to make sure the transaction is worth your while.
Size matters when researching companies for a possible trade. It is a very good practice to trade stocks that have a market capitalization (market cap for short) of at least $5 billion. Market capitalization indicates the total monetary market value of a company’s outstanding shares of stock.
The bigger the market cap, the more financially stable a company and therefore its shares of stock are. Stocks with a decent market cap move and in doing so provide us with opportunities to trade and make a profit, either shorting (selling) or by going long (buying). It’s also worth checking that there isn’t an imminent takeover of the company on the horizon, as this might adversely affect share prices.
Conditions Relating To The Price Of The Stock
Price is king and everyone loves a bargain. In the global supermarket of stock trading you’re spoilt for choice and we want to make sure that we’re trading any given stock at the best price. That makes it imperative to wait for the price to break out of a trading range and begin to trend before we buy. This means that our trade can benefit from the underlying momentum and that will price it towards the direction we want.
Liquidity and Volatility
It’s always best to trade a stock with good liquidity. Liquidity relates to the stock having enough market participants trading it for trading orders to be filled quickly and easily. The market is then said to have depth and the stock trades with ease.
The more liquid a stock is, the more stable and less prone to price fluctuations (volatility) its price will be. A “thin” stock, with few market participants, will experience unpredictable price fluctuations (volatility) which is not good for anyone’s purse. It is best practice, especially when starting out, to trade a stock that is liquid with no erratic price movements.
The price of the stock we want to trade has to be free to move in the direction we want in order for it to generate any profit for us. Obstacles in its path, in the form of significant support or resistance levels, can stall its progress and cause price action to become choppy. Price could well reverse at these support and resistance levels and end any hope of making a decent profit from the trade. It is therefore a good idea not to trade stocks with any significant roadblocks on its path.
Conditions Relating To The Broker
For any stock we wish to trade, we pay a “spread” to the broker. The spread is the difference between the “Ask Price”, which is the price at which we buy the stock, and the “Bid Price”, the price at which the stock is sold. If the spread is wide, it can eat into our profits significantly. Ideally you want to trade a stock where the spread is not too wide.
Something else to bear in mind is that the broker will usually charge you a commission for the privilege of doing business on its platform. This is essentially another spread. The total charges you pay to the broker will consist of the spread and the commission so you want to check these to make sure you’re making these trades for your own profits, not just theirs.
Conditions Relating To The Buyer
It’s awful to get the end of the checkout line and see the total flash up only to realise you’re a little short of cash. Whilst you can always nip home to grab your wallet or purse, come back to the supermarket and still pay the same price as before, in stock trading (depending on timescales), the delay in sorting out your account admin can well mean when you come back to buy, the market had moved away from you and is no longer viable. When buying stocks at the right time, you need to make sure you make available sufficient funds for the intended transaction to go ahead.
Even more like the current world, you need to make sure you are in good health before venturing out. You, the buyer, should be physically healthy and psychologically fit to think through and execute the purchase of a stock. If you’re feeling fuzzy or frantic it will have an effect on your capabilities. Whilst in the supermarket, this might mean coming back with an unwanted extra tin of peas, the repercussions on your trades can be much more dire. Always make sure you’re feeling well and are in a good mental space before trading stocks.
So, when should you trade a stock? The best time to place trades is when you are ready to do so. You need to have enough money to cover the cost of the transaction. You need to be sure that the stock is worth investing in, that the price is right, that the stock has sufficient liquidity and that the price is not wildly fluctuating. You also need to make sure you’re not getting ripped off. Check that the spread is not too large and that the commission charged by the broker is reasonable. These points should provide a minimum set of standards for your trades; a solid framework that can be used when considering starting to trade in stocks and shares as well as the best time to do so. Good luck!
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