In theory, the idea of stock trading or buying stocks online seems like a simple task. Simply put money into a brokerage account, then buy low and sell high. Watch the money roll in from compound interest, and calculate the time for funds to double using the Rule of 72. In reality, that is far from the truth, and the actual nuts and bolts of investing should be thoroughly understood before a penny is placed into a brokerage account.
Investors should first narrow down the number of companies they plan to invest in by using tools like Zacks Stock Screener. Most brokerage accounts have proprietary tools to help narrow an investor’s focus to a handful of stocks. These tools will help the investor find companies that offer dividends and consistent earnings that meet his or her criteria. Investors should have an ideal market capitalization size and know the percentage of institutional investors buying and selling their target stock. Institutional investors buying a stock can be an indication that larger investors like money managers are bullish on a stock, whereas the selling of a stock can indicate that it is about to drop in value.
Investors should also have an understanding of how expensive or inexpensive a stock is at today’s market price. This can be done by reviewing the trailing 52-week trading range. The trading range should also be reviewed with the beta of a stock over that time period. Beta is the assessment of risk for a given stock as compared to the rest of the market. A stock with a beta of 1 signals the stock will move in concert with the market, whereas a stock with a beta of 1.5 will move on average of 1.5 times more than the market. A beta below 1 indicates the stock is less volatile than the market.
These are just a few of the parameters that should be considered before depositing money into a brokerage account and ultimately buying stocks online. Once key parameters are selected, the next step for an investor should be to write down in a log the reason for selecting each stock. If the target stock initially has a high dividend yield and a beta close to 1 and these parameters are key for a successful return, then these factors should be logged. It is critical to keep a log of why a stock was purchased and what the desired return is to remove emotion from an investment; volatility in the stock market is inevitable. All too often, investors are emotionally attached to a stock, and fluctuations in the price of the stock can alter the investor’s decision process.
A written log will help an investor determine whether a stock should be sold or purchased when stock prices move up and down. For example, if an investor had purchased shares of the Royal Bank of Canada at $67.28 per share on April 29, 2015, and one of the key reasons for the investment was a dividend yield of 3.68%, then a hard decision might have had to be made when the stock plummeted to $45.26 on January 20, 2016. This is a loss of 32.7% over this 8-month period. If a log is not kept, it might be easy to forget that one of the initial reasons for the investment was the dividend yield. In fact, on January 20, 2016, the dividend yield was 4.87%. If all other parameters are equal, it would be a prudent decision for the investor to purchase more shares of the Royal Bank of Canada RY 62.74 +0.27 0.43% at a lower price. If the investor had made this decision, he or she would have been pleasantly surprised to see the stock price rebound to $62.12 per share and a dividend yield higher than when he or she first invested: 4.05%.
Roundup: Buying Stocks
Prior to putting any money into a brokerage account and buying stocks online, an investor should understand what return will make the investment successful to them. The investor should have a realistic expectation about the investment and remove emotion from the stock trade. It is important to look at key factors such as the 52-week trading range, percentage of institutional investors, dividend yield, company earnings, market capitalization, and beta (this is not an exhaustive list of parameters, but they are key factors in the decision process). A written log should be kept to remind the investor why the stock trade was made. Time and emotion can cloud an investor’s decision-making process. These tools will help an investor be successful and prevent emotional investment decisions.