New investors are often understandably confused by how stocks are priced. The bewildering truth is that in many cases there
are two prices, mysteriously called the bid and ask. The discrepancy results from the fact that stock is always being bought
and sold. From the investor's viewpoint, the bid is the price when selling, and the ask is the price when buying.
Imagine the person you're buying from. This person actually exists in the form of a market maker, a professional from whom
investors buy and sell. A market maker is simply a product distributor, and stock is the product. Like any other distributor,
a market maker earns money by marking up the cost of the product. Since market makers buy and sell this product all day, they
price it differently depending on whether you are buying or selling. Obviously, they charge a higher price to buy stock from
them, and offer a lower price for stock you want to sell to them.
The difference between the bid and the ask is called the spread. It is sometimes possible to beat the spread (buy stock lower
than the ask price, or sell stock higher than the bid price) by placing a limit order between the two prices. In a volatile
marketplace, the prices are always jumping around, but they remain tied to each other. In high-volume stocks, the spread is
small, sometimes just 1/16 of a point which is .06
There is a thrilling moment of empowerment before you make your first online stock purchase. You are playing in the market
right there alongside the big boys of Wall Street. Before you set the wheels in motion by clicking that on-screen button,
there are some basic decisions to make.
Are you using a market order or limit order? Market orders direct the brokerage to buy and sell stock at prevailing prices as
soon as you place your order. Limit orders define the price you're willing to pay or receive. When placing a limit order, you
must decide whether it should expire if not filled by the time the market closes (a day order, or good for the day), or
should remain open until you manually cancel it (a good till canceled order). (Note: Most online investors use limit orders
as a matter of course, never placing a market order into a volatile stock market. Limit orders should be strongly considered
when buying volatile stocks, and can't hurt when buying in calmer waters. Market orders, by contrast, can hurt very much if
your broker executes your trade at a price much higher than you expected.)
Once you place your order and are finished with your celebratory dance about the room, you should check the order
confirmation. In the case of market orders, that confirmation should appear on your screen (or on whatever page to which your
brokerage directs you) within a minute, or even seconds. Limit orders may take longer, as the market must match your
predetermined price. Some investors deliberately place limit orders in anticipation of a stock's movement, and wait for days
or weeks for the orders to fill.
Once you receive confirmation of your transaction, you may not need to do anything for a while, especially if you plan on
holding your stock for a long time. When to sell is entirely up to you, and involves initiating another transaction when
you're ready.
You can, however, place a sell limit order immediately after receiving confirmation of a purchase, which specifies a
particular price at which to sell. For example, if you bought a stock at 50, you can specify a sell limit of 60, meaning your
broker will automatically sell your shares once the stock reaches that price.
If your stock has made a nice run-up and you want to protect part of your profits, you can put a stop loss on your shares,
which is a price you specify underneath where the stock is currently trading. If it falls to your stop loss price, your
broker will automatically sell your position, locking in some profits and avoiding a possible freefall back to where you
bought the stock, or worse, falling even further than that. For example, let's say you bought a stock at 50, and it's run up
to 100. If you're a little anxious about the price dropping back to 50 and watching your gains evaporate, you can specify a
stop loss of 90. If the stock drops to 90, your broker sells your shares, and you've locked in a profit of $40 a share. But
if the stock continues its ascent past 100, then nothing happens, and you enjoy an even greater paper profit. Note also that
you can continue to move your stop loss up as the price ascends, protecting even more of your gains along the way. Be
forewarned, though, that your stop loss may not get executed exactly at the price you specify. Extremely volatile stocks can
plummet past your stop price before your broker has a chance to act, or in an overnight move, may open below your stop price.
Stop losses are not absolute protection, merely general protection.
Over the last decade, personal investing has filtered into our culture and brought Wall Street to Main Street. Information
and trading techniques that were previously only available to the pros are now in the hands of every individual investor.
With all this freedom and empowerment comes great risks as well. Once you discover just how easy it is, using a Web broker
can lead to excessive trading, and invite rash and compulsive decisions. Don't get caught up in hype and let your emotions
get the best of you. Do your homework, choose a level of risk that you're comfortable with, and execute your trades wisely.
Just remember that online investing is only a tool to help you achieve financial security and reach your life goals. Good luck!
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