A person starts to look into more avenues to get a better return on their money. Two of these methods are investing and trading in the stock market. People often confuse these as the same thing. Investing is purchasing assets for the purpose of growing wealth. On the other had, trading is a zero sum game. When you trade you are looking for profits either buy low sell high or sell high buy low. The former is the normal way to purchase whereas the latter is shorting a position.
When a person invests, they buy a market instrument with the intention of holding it for a long time. These market instruments are things such as bonds, stocks, REITs, ETFs, mutual funds, or debentures. Some of these instruments pay the investor via a dividend, distribution, or interest. These payments can be monthly, quarterly, semi-annually or annually. Dividends and distributions can be increased, decreased, or eliminated. Interest payments by bonds do not change after the purchase.
The markets are volatile. Over long periods of time, the overall return of the stock market beats returns from real estate. The most successful investor in history is Warren Buffett. Warren Buffett says, "His favorite holding period is forever".
Why Do People Trade?
Some people are drawn to trading as the believe they will have the life of the nice cars (Porsches, Lamborghinis, and Ferraris), yacht and the big house with a pool.
Most brokerages have a website as a platform, When you buy a stock, you are said to be long the stock. When you sell a stock without owning the stock first, this is known as shorting. To close a short position, you buy to cover the position. Shorting involves a few steps which are:
- Borrow from your brokerage
- Then you make an exchange by selling to another person
- Cover (buy it back)
- Return the shares
With shorting you just click on sell and confirm. The shares are borrowed and than sold to a person. The result of this step is that you receive money from the sale. When you want to close the position, you put in a buy order (covering the stock). When the buy order is executed. you pay the price for the shares and then they shares are automatically returned to the brokerage. When shorting, you want the price of the stock or instrument to go down. Basically, you pocket the difference between what you sold it for and what you bought back the shares.
When you short a stock, your risk is unlimited as the price of the instrument can go up and up. When you go long a stock, your risk is what you paid for your shares.
Many discount brokerages have a website for their basic platform and separate program as a stand alone application. A person can invest or trade using the website. However, these websites are more geared for the investor. As an investor, you are holding on to the stock for the long term, so the price volality day to day is not of major concern. However, you take advantage of order types to limit your loses or to lock in a profit. The platforms for trading are often a stand alone application. An example of this is the discount brokerage Questrade. If you use the website to login, you will be able to see a basic site that can be used to buy and sell stocks and regular orders. When people buy a stock to hold for the long term, they will not put a STOP order before they even execute the buy order. Also, they will not set a stop order as they will hold the investment for a very long time. Questrade also has stand alone application called Questrade Edge, which can be downloaded from the website. Questrade Edge allows a person to view risk graphs, better charts, more order types etc.
An order type that is beneficial to a trader is a bracket order.
When a person wants to go long they can choose the entry price, exit price and a stop order to limit their losses if the stock goes against them all in one order. Obviously, the exit price will be hire than the entry price and the stop order will be less than the entry point. The exit and stop loss orders are contingent on the entry point order being executed or not. Once the exit and the stop loss orders become active, the one that gets executed will automatically cancel the other.
A trader can also use a bracket order when shorting. The difference would be that the buy to close would be set a lower price than the sell price (entry price) and the stop loss would be set at a hire price than sell price. When shorting a stock, the risk one takes is infinite as the stock can go up and up in price. So, a stop loss order will limit your loss. In Questrade Edge, a stop loss order (market order) is not allowed on Canadian Exchanges. Instead, a stop limit order is used when you pick the stop price and an offset. For example, if a stock is trading at $30 and the stop limit is set for $29 and an offset of $0.05 then you stop would be executed at any price between $28.95 to $29.00. It is usually best to set the offset to $0.05 or more, to limit the chance of blowing through the stop price.
Some people think trading is used to pay the bills such as electric bill, gas bill or mortgage. If you approach trading like this then you will end up with nothing. All traders have losing trades. Basically, the idea of trading is to risk a X percentage of your account to make 2X or more percentage. For example, if you risk 2% on a $10000 account means that you are risking $200 to try to make $400. So by managing your risk via stop orders, a trader can trade another day. Money management is extremely important to the success of a trader. It is all in the risk to reward ratio. A trader should set goals such as if account reaches $10000.00, 3% will be moved to an investing account. The investing account can be used to purchase income generating assets that can be used to pay bills in the future. I believe a trader should already have an investment account throwing off passive income prior to starting trading.
Why Do People Not Want To Trade?
People believe trading involves staring at the monitors constantly all day long. Being a trader does not mean you have to look at the monitors all day long. People often hear that 90% of traders lose money. No wonder people do not want to be a trader.
Tax Treatment of Trades
Completed trades are taxed different then dividend income. Trades are taxed as capital gains or losses. In the United States, positons for less than a year are taxed as short-term capital gains. The short-term capital gains rate is higher than long term capital gains. In Canada, the Canada Revenue taxes capital gains as either "capital" or "income". To be treated as capital, the person will have more sources of income which make up a bulk of their income. When being treated as capital, the tax rate is 50% of your marginal rate. Your net capital gains is equal to the total capital gains minus total capital losses. If you trading is set up as business or the government considers it income, then you will be taxed at 100% of marginal rate.
How To Be A Successful Trader
A person can be successful in trading if they follow money management principles. A person must lean about performance metrics like intra-trade drawdown, accuracy rate, risk, reward, and risk to reward ratio. Using a bracket order can help limit your losses. Ideally, a trader wants to keep track of intra-trade drawdown for all their trades. Average intra-trade drawdown shows how much trades move against you. So, the average intra-trade drawdown shows a trader how good or bad they are at picking entry points.
You can make exceptional money in trading but it will be a slow process. Do not believe all the hype that you be living in mansions or having expensive luxury cars within a couple years. Do not take money out of your account on an ongoing basis to pay bills or to treat yourself. The account balance will have to be a large amount prior to taking money out consistently. Treat trading as a business , whereas the account balance is your business. The goal is to grow your account size.
Even the most successful traders in the world have losing years.
You can see my trading results by clicking on the Trading tab above.
An order type that is beneficial to a trader is a bracket order.
When a person wants to go long they can choose the entry price, exit price and a stop order to limit their losses if the stock goes against them all in one order. Obviously, the exit price will be hire than the entry price and the stop order will be less than the entry point. The exit and stop loss orders are contingent on the entry point order being executed or not. Once the exit and the stop loss orders become active, the one that gets executed will automatically cancel the other.
A trader can also use a bracket order when shorting. The difference would be that the buy to close would be set a lower price than the sell price (entry price) and the stop loss would be set at a hire price than sell price. When shorting a stock, the risk one takes is infinite as the stock can go up and up in price. So, a stop loss order will limit your loss. In Questrade Edge, a stop loss order (market order) is not allowed on Canadian Exchanges. Instead, a stop limit order is used when you pick the stop price and an offset. For example, if a stock is trading at $30 and the stop limit is set for $29 and an offset of $0.05 then you stop would be executed at any price between $28.95 to $29.00. It is usually best to set the offset to $0.05 or more, to limit the chance of blowing through the stop price.
Some people think trading is used to pay the bills such as electric bill, gas bill or mortgage. If you approach trading like this then you will end up with nothing. All traders have losing trades. Basically, the idea of trading is to risk a X percentage of your account to make 2X or more percentage. For example, if you risk 2% on a $10000 account means that you are risking $200 to try to make $400. So by managing your risk via stop orders, a trader can trade another day. Money management is extremely important to the success of a trader. It is all in the risk to reward ratio. A trader should set goals such as if account reaches $10000.00, 3% will be moved to an investing account. The investing account can be used to purchase income generating assets that can be used to pay bills in the future. I believe a trader should already have an investment account throwing off passive income prior to starting trading.
Why Do People Not Want To Trade?
People believe trading involves staring at the monitors constantly all day long. Being a trader does not mean you have to look at the monitors all day long. People often hear that 90% of traders lose money. No wonder people do not want to be a trader.
Tax Treatment of Trades
Completed trades are taxed different then dividend income. Trades are taxed as capital gains or losses. In the United States, positons for less than a year are taxed as short-term capital gains. The short-term capital gains rate is higher than long term capital gains. In Canada, the Canada Revenue taxes capital gains as either "capital" or "income". To be treated as capital, the person will have more sources of income which make up a bulk of their income. When being treated as capital, the tax rate is 50% of your marginal rate. Your net capital gains is equal to the total capital gains minus total capital losses. If you trading is set up as business or the government considers it income, then you will be taxed at 100% of marginal rate.
How To Be A Successful Trader
A person can be successful in trading if they follow money management principles. A person must lean about performance metrics like intra-trade drawdown, accuracy rate, risk, reward, and risk to reward ratio. Using a bracket order can help limit your losses. Ideally, a trader wants to keep track of intra-trade drawdown for all their trades. Average intra-trade drawdown shows how much trades move against you. So, the average intra-trade drawdown shows a trader how good or bad they are at picking entry points.
You can make exceptional money in trading but it will be a slow process. Do not believe all the hype that you be living in mansions or having expensive luxury cars within a couple years. Do not take money out of your account on an ongoing basis to pay bills or to treat yourself. The account balance will have to be a large amount prior to taking money out consistently. Treat trading as a business , whereas the account balance is your business. The goal is to grow your account size.
Even the most successful traders in the world have losing years.
You can see my trading results by clicking on the Trading tab above.
DISCLAIMER
I am not a financial planner, financial advisor, accountant or tax attorney. The information on this blog represents my own thoughts and opinions and should NOT be taken as investment or business advice.
Depending on the trading instruments used, the loss can exceed your initial investment or outlay of capital. Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk.
Depending on the trading instruments used, the loss can exceed your initial investment or outlay of capital. Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk.
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