When looking to buy stocks, there are a few ways to go about it. Whether you’re talking to your broker or trading online, the same terms apply.
The first term is to buy in Market. This means that you are willing to pay the current price for the shares, as determined by current demand. If you really want to buy stocks at any price right now, this is the way to do it. You are relinquishing control to the market. Your broker or program will snatch the shares you want at the current market price. For example, you want to buy 200 shares of XYZ at market price. When he was initially looking at the company, doing his Due Diligence, the price was $5. That seemed like a good entry point, so the next day you place your market order. Unknown to you, some other people saw the same stock and also placed orders. The price rose to 7.50, so that was where he bought his shares. Total cost, $7.50 X 200 shares plus a $10 transaction fee = $1510. If you really wanted the shares, and $7.50 also fits your good price model, you are the proud owner of 200 shares. If you didn’t want to spend $7.50, too bad, you still own the shares. How could you have prevented this?
The next term is called Limit Order. This works similar to a market order, in that you keep saying you want the 200 shares, but you call the price. If you place the order and it says Limit 200 shares $5 per share, then $5 is the maximum price you will pay. You are limiting the price. If the price has gone up, you won’t get the shares. You can also make this have a defined term by saying the order is good until you cancel it or until the end of the day. You can define the timeline in which you are willing to enact that trade. With the limit order, your cost will be $5 X 200 shares plus a $10 transaction fee = $1010. However, the trade may never go through if the stock does not see the price of $5 again. On the other hand, if the price is less than $5 when you place the order, you will get the lower price and the total cost will be lower. The limit doesn’t say, “I’ll pay $5.” Set the maximum you are willing to pay.
The flip side of this is, of course, selling stocks. You must first realize that there are two categories of sales. The first is short term and the second is long term. This is strictly a factor of how long you hold a stock. The dividing line is 365 days. The difference between the two is the tax rate on your gain. If you hold a stock for less than a year, the gain (assuming you have a gain) is taxed at your current tranche. If you hold a stock for more than a year, it is taxed around 15%. This was implemented to add stability to the market. If people did not have this tax rate in mind, the market would be much more volatile. For more information on short-term and long-term gains, see This
Another thing to keep in mind is the fees associated with your buying and selling. If you’re a small-time investor, especially, this can give you a good beating. For this discussion, I am going to remove taxes from the equation. If you buy A shares for $10 per share and get 10 shares; its total cost is $100. (I realize this is a low number, but it’s for illustrative purposes only.) in E-trade that is $12.99. So instead of $10 per share, you paid $11.29 per share.
cost breakdown
$100/10 shares = $10 per share
($100 + 12.99)/10 shares = $11.29 per share
So here it is one year after you decide to sell this stock, and the price is $12.50 per share. That’s a 25% profit. Nice trade, smart move. Or is that it?
When you sell the shares, you receive the same trading cost of $12.99. So we actually pay $11.29 per share, so the profit is not $2.50 but just $1.21 per share. When you add in the cost of the sale, it’s even lower. Look at the table.
purchase price
($100 + 12.99)/10 shares = $11.29 per share
Sale price
($125 – 12.99/10 shares = $11.20 per share
gain loss
$112 – $112.90 = – $0.90
So after one year you have $99.10 instead of $100. This is obviously an exaggerated case. But even if you were to add another 90 shares and say you bought 100 shares, the impact in dollar terms is still the same. Your profits are minimized by the cost of trades. The only difference is in the percentages. On the “buy” side, the additional trading cost brings the price per share to $10.13 ($1012.99/100 = 10.129) and the same is true for selling. The sale price is $12.37 per share. The profit in the 100 shares scenario is $224.01.
This is a fairly simple concept, but one that people can overlook when trying to make “quick money.” Last year I paid $467 in business fees. If you had a small portfolio, that could be a large percentage and could wipe out any profit you might have made.