What is Online Trading?
Online trading is the process of selling and buying financial securities on the internet using an online trading platform.
An online trading platform is a software used to buy and sell financial assets. It allows investors and traders to place and receive offers on the market through the internet. Brokers or self-directed investors usually run online trading platforms. Fidelity Investment, Ally invest, Zacks Trade, Robinhood and FirstRade are among the top online trading platforms.
Brokers are individuals or firms that help you to buy or sell stocks on the internet in exchange for a commission. In general, there are two main types of brokers: full brokers and discount brokers.
The main difference between the two types resides in the fact that full brokers offer full service (investments products, advice on your investments, market study), while a discount broker only places your order but never provides any information on the investment you are about to make.
In result, full brokers' service is always more expensive than the service offered by discount brokers.
Traditionally, buying and owning stock was a privilege only reserved for rich and powerful people. Nowadays, having a computer, some extra money and basic notions of online trading are all you need to invest in the stock market.
What is the meaning of financial securities and how does online trading works?
What are financial securities?
Also referred to as financial assets or financial investments, financial securities include stocks, bonds, holdings, commodities, currencies or any other financial asset that holds monetary values.
There are three main types of financial securities:
1. Equity securities
1. Equity securities: Equity securities are basically the amount of money that a person or another company invests in a business or corporation by buying its shares. Equity securities are usually in the form of common stocks.
A company will most likely decide to go public and offer its stock to increase its capital and expand the business, or to pay off its debts. Therefore, buying a share is like contributing to increasing the company's capital.
For example, a company A offers 10.000$ shares of 10$ each. Buying a share in company A means that you have invested 10$ to its capital. Interested people or even other companies (shareholders) can purchase shares of the stock and gain ownership of the company.
These investors buy the business' share in anticipation of receiving dividends (money paid to a company's shareholders out of its profits) and in hope to increase the invested amount (capital gain).
The stockholders' ownership resides in the fact that the investors own a small portion of that company's assets and income. Moreover, they hold the right to vote on the company's major decisions.
Shareholders will have a return on their investments only when they sell their shares to other interested investors or when the business' assets are liquidated, and all obligations have been fulfilled.
Like any other type of investment, equity also has disadvantages: If the company goes into losses, the investors only share residual interest after paying all creditors, which means that they may lose all of their investment.
Fluctuations in the stock market price, liquidity, foreign currency, credit, inflation are amongst the types of risks that influence equity securities directly. Dividend from the company's profit is not either guaranteed, investors may or may not get them.
2. Debt securities
Debt securities are tradable loans made to a company, and corporate bonds are the most common type.
Corporate Bonds represent loans offered by investors in exchange of interest. In this case, investors are creditors of the company.
Bonds are issued for a fixed period of maturity (usually long-term period); the company has to pay yearly interest to the investors and the invested amount at the end of the fixed period.
In case of loss, the company's assets sale value will be used to pay off the creditors' initially invested money.
3. Derivative securities
A derivative security is a security whose value depends on an underlying asset such as stocks, bonds, commodities (wheat, oil, gold), market indexes and interest rates. There are four main types of derivative securities including Futures contracts, forward contracts, swap contracts, and option contracts.
In this type of investment, investors are usually speculators. A futures contract is an agreement between two parties to sell or to buy product or money at pre-agreed prices and at a specified time in the future. The buyer of a futures contract has to purchase the products at the date of maturity (at the fixed date). In the same time, the seller has to deliver the products at the set date.
Futures contracts benefit companies who want to protect themselves from future price changes. At the same time, they help investors who will profit from the change in prices.
Similar to futures contracts, forward contracts are also agreements for the seller to deliver products at a fixed time in the future at a predetermined price.
The difference between Futures and forward contracts is that future contracts can be settled daily while forward contracts can only be settled at the end of the contract.
A call and a put are two main types of Options contracts. A call option allows the investor to buy assets while a put option will enable you to sell assets at a set price (strike price). Generally, one call/put refers to 100 shares.
Investors buy calls in hopes that the market price of the asset goes up and they sell to put in beliefs that the market price of the asset decreases.
The benefits of options contracts are that you are not under the obligation to wait until the expiration date; you can leave it any moment you choose.
These types of derivative contracts are mostly used between businesses or financial institutions. It is also an agreement between two parties to exchange interest rate payment or cash flow with another company of financial institutions.
Investors use swaps contracts to speculate and manage risks.
How does online trading work?
Just a while ago, before the internet era, an investor would likely contact a broker by telephone and place his order. The broker would then make another call to another trader working at the exchange market to find a match to the investor's order. Finding a match, however, could take time and by the time the broker had seen a match, the market price could have changed.
Fortunately, with full access to advanced technologies, we can now place an order immediately either by ourselves (self-directed investors) or with the help of an online broker. Let's use the example of a common stock market to explain the process of online trading.
As an investor, a computer, an online trading platform, access to the internet and money is all you need to enter the online trading business.
Online trading is easy to get into; however, it may take time to turn it into a profitable business finally.
Below are a few steps on how to start trading.
1. Find a broker
The very first step you need to take is to write a trading plan, then find a reliable broker. Online brokers will help you open and maintain your trading account.
Also, depending on the type of brokers you choose to work with (full or discount brokers); you will be advised on financial investments and the stock market before placing your order.
SmartMoney is a guiding website that you can use to check ratings (from the most reputable and secure to the least) of several online brokers' services.
Additionally, SEC (Security and Exchange Commission) re NASAA are among the organizations that offer authentic information on the business of online trading.
2. Set up a business account
Once you have chosen an online broker, he will then ask you for your personal information such as identities, telephone, and address, social security number) and for your investment history. The investment history will sometimes determine whether you can enter the business or not.
The principal types of account are individuals, joint, retirement or custodial accounts.
You will need money to open a trading account and start buying stocks. In fact, you are only eligible to buy a stock when you have at least 50% of the stock price in your account.
3. Start making trades
If you want to place an order, your broker will send you quotes which are basically the price of the stock you want to buy. These quotes are separated between two categories: real-time and delayed quotes.
Real-time quotes, mostly offered by full brokers, instantly show you the real price of the stock on the market. Delayed quotes, on the other hand, will show you the price after 15 to 20 minutes.
If you are dealing in a fast market, those two prices can be significantly different.
The next step is determining whether you want to place a market or limit order. A market order, the basic one, is made at the current price and is very easy to execute as many apps are equipped with a ‘'buy'' and ‘'sell'' button. A limit order allows you to buy or sell a stock a specified price or higher.
In all cases, you must specify the duration of your market order until you cancel it.
Online trading is another form of business, and it takes time to start making a significant profit (it can take time to find a buyer or a seller). Thus, before placing orders take time to learn basics notions and chose which financial asset you want to focus on.
Secondly, write a business and trading plan and stick to it.
In the third position, seek advice from the market's experts to help assess and analyze the market. This option may sound expensive, but it is better than losing all your money before even starting your business.
Lastly, make sure you have enough funds; the more money you invest, the more you gain. In online trading, there is no way to contain or avoid risks; you will need to have enough money to take on the eventual yet inevitable risks.
In conclusion, investors need to be careful when trading their financial securities; much like gambling, you will either make a fortune or lose all of your money.
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