Introduction
Buying the right stock shares for a fair price is the most crucial step in your investment journey. Yet the stock market motto—‘buy low, sell high’—is also the easiest to mess up for beginners.
There’s no need to feel bad if you’ve been overpaying this whole time. The truth is that many investors are guilty of this when they first start investing (including myself).
With the right knowledge and tools, you don’t need to put your investment goals at risk. Your ability to avoid making these rookie mistakes could very well determine your financial success.
Here are the trading strategies that can maximize your earning potential.
Investment Philosophy: Maximize Potential Returns
Here at Breakaway Limit, we always try to make the most of our time and money. It doesn’t matter whether it’s in the stock market or any other aspect of our daily lives.
But you may be wondering: does losing out on small profits matter that much? Is it necessary to squeeze every last dollar out of your stock trades?
Our verdict? Yes!
After all, you could become a millionaire by investing only $5 a day. So losing out on $5 a day could cost you over $1 million in the upcoming years. Every dollar counts, especially if you want the returns needed to become a billionaire.
Investment Vehicle: Avoid Taxes
Out of all the stock investment vehicles, which one is best?
Our preferred account is the Roth IRA—it’s by far one of the most versatile retirement accounts you can have.
Although you can only contribute a $6000 to a Roth IRA in 2020, you don’t get taxed on profits. As a result, you can reinvest your earnings without losing any to taxes.
If you need a Roth IRA account, check out WeBull. You’ll get two free stocks valued up to $1,400 as a bonus for signing up using this link and making a deposit. You also won’t pay any commissions for trading stocks or options!
Not sure why reinvesting earnings is vital to healthy portfolio growth? Check out this beginner stock investment guide to learn about compound interest.
Dollar-Cost Averaging: Avoid Consequences of Price Swings
Would you like to reduce the effects of wild stock market swings on your portfolio? If you can’t handle the significant price swings in stocks, dollar-cost averaging is for you.
To perform this strategy, invest a fixed dollar amount at set time intervals. For example, you could contribute $300 weekly to your 401(k) or deposit $500 a month into your Roth IRA.
Dollar-cost averaging requires committing to the plan regardless of the share price. Unlike the typical investor, this investment strategy takes the emotion out of investing. It prevents you from trying to predict and time the market, which is impossible.
Suppose the stock market is doing well, and your favorite stock costs $100. Your fixed dollar amount of $500 limits you to only five shares. Now, if the stock price drops to $50 next month, you can scoop up twice the shares for a discount.
Dollar-cost averaging operates on logic, leaving little room for emotions and poor decisions. You’ll pick up stocks no matter how the market is doing and enjoy long-term growth—if history is any indicator.
Employ the dollar-cost averaging strategy with an index fund if stock-picking isn’t your cup of tea. It’s perfectly acceptable and may even generate higher returns in the long-term.
Your money will work for you regardless of whether you glue your eyes to stock charts all day. It takes all the thinking and emotion out of the process, so you can focus your attention where it matters.
Buy Low, Sell High: Avoid Emotional Investing
When the stock market reaches highs, emotional investors engage in FOMO* investing. They buy stock shares at their peak in anticipation of making money.
*FOMO is an acronym for “fear of missing out.”
But if the trend reverses and prices come crashing down, they end up panic-selling for less. This trading mentality is the opposite of ‘buy low, sell high.’
Many investors let their emotions dictate their trades rather than logic. Put yourself in their shoes for a moment; would you act any differently? Most people want to earn easy money and avoid losing it.
But rather than looking at stocks from a price standpoint, view them from a value standpoint. You wouldn’t panic if your favorite item at the store goes on sale, would you?
Why should stocks be any different? You might even consider it an opportunity to load up on shares if the company has a strong financial record.
Other investors can violate the ‘buy low’ principle and chase stocks out of greed if they want. But while they’re overpaying and selling at a loss, do the opposite. Wait for an excellent opportunity to buy stocks at a discount and increase your profits.
That doesn’t mean you have to sit on the sidelines while waiting for stocks to go on sale. There are strategies to earn money while waiting for stock discounts (which we’ll get into later).
Capital Gains and Sale Conditions: Avoid Unnecessary Taxes
Unless you’re of Warren Buffett’s ‘buy and hold forever’ mindset, create an exit plan before you buy the stock. Failing to plan is planning to fail (which often involves emotions).
It’s imperative to define how long and under what circumstances you’ll be holding on to your trade.
Consider what conditions it would take for you to sell the stock. Is there a price at which you’re willing to take profits? How long will you hold a falling stock before selling it?
Furthermore, not all profits have equal tax treatment. When you sell a stock you’ve held for more than a year, they earn the long-term capital gains designation. Otherwise, they receive short-term capital gains treatment.
Long-term capital gains are one way in which you can reduce your taxes. For most people, this tax will set them back only 15%—0% in lower tax brackets. Meanwhile, short-term capital gains get income-tax treatment, which is higher.
Avoid selling stocks until they qualify for long-term capital gains status. This way, you’ll walk away with more of your profits.
As you can see, defining your endpoints can result in increased long-term profitability. Whatever the sale conditions are, set them BEFORE you buy the initial shares.
Market Orders: Fast But Sometimes Costly
Your first order was likely a standard market order—buying a stock at its best available price. You might have even waited for a drop in stock price before hitting ‘Buy,’ but still ended up paying more. What gives?!
Unfortunately, your brokerage’s market order function is dumb. It doesn’t know that you’re getting a bad deal on your stocks. Or it does, but pockets the difference!
The listed price is the average of the current highest buy offer (bid price) and the lowest sell offer (ask price). By placing a market order, you’re telling the broker to execute the trade at the current ask price—no matter how high.
So even if you see a stock listed at $100, it might have a bid price of $50 and ask price of $150. Guess what you’ll be paying per share if you place a market order for this stock.
If you guessed $150, you’re right. Even though a market order executes at the best available price, it isn’t the best possible price you could get. There are many more opportunities to cut costs.
The spread—or difference between the bid and ask price—usually depends on trade volume.
Popular stocks have many traders competing to offer the lowest ask prices. As a result, these stocks have higher trade volume and lower spreads. You can execute market orders on these without risk of overpaying by too much.
But with lower trade volume stocks, placing market orders may work against you. Inflated ask prices result from less competition to offer the best price.
To get around this situation, we can place what’s known as a limit order.
Limit Order: Take Advantage of Price Swings
Suppose you still wanted to buy a stock priced at $100 (with a $50 bid and $150 ask price). You could place a limit order to buy instead of a market order, so you don’t end up paying the $150 ask price.
By setting a limit order to buy at $50.01, you tell the broker this is the most you’re willing to pay for the stock. It also puts you first in the queue, because you’re outbidding the current highest bid price of $50.
As the highest bidder, you’ll be first in line to purchase any market OR limit orders to sell priced at $50.01 or lower.
You don’t have to make orders to buy the shares by the end of the day. If you expect the stock’s value to drop in the future, you can create a good-until-canceled limit order that may execute in the future. Until the trade is complete or cancelled, the order will remain open.
In theory, it’s possible to set your bid price as low as you want. Whether the order will execute is another matter altogether. But as long as you’re trading commission-free, it can’t hurt to try!
Extended Hours Trading: Take Advantage of Low Trade Volume
While limit orders enable you to buy cheaper stocks, it’s possible to pay even less.
We avoided overpaying from low trade volume and high spreads by using limit orders. But now we’re going to take advantage of that!
Due to lower trade volume, you may be able to pick up stocks for less before or after market hours.
While low trade volume means fewer sellers undercutting each other, it also means fewer buyers outbidding each other. If you place an order that’s even $0.01 higher than your competition, it’s less likely someone will outbid you.
Congratulations, you’re now the highest bidder and first in line to buy the stock.
So consider a stock that is usually $100 during trading hours. Suppose nobody buys during extended hours and you have the highest bid of $80. If someone executes a market sell order during that time, you’ll pick up the shares at a $20 discount.
Although not the most reliable method, it’s possible to buy a particular stock at a price you didn’t know was possible. I’ve actually gotten a $15 discount on a $90 stock by doing this before.
Keep in mind: this strategy doesn’t work as well on stocks that have large trade volumes at extended hours. Feel free to try it on less popular stocks, though!
Take advantage of discounted shares during extended-hours trading by signing up for WeBull. It has the most before and after-hours of any online brokerage, spanning from 4 AM to 9:30 AM and 4 PM to 8 PM EST. You’ll also get two free stocks valued up to $1,400 when you sign up and make a deposit using this link.
Options: Flexible Trading Opportunities
What if you could do better than just ‘buy low’? With options, you have much more versatility than buying and selling stocks. You can set lower prices than limit orders and even generate profits on the way.
Investors generally consider options trading an advanced strategy. But even beginners can leverage their potential to make more profitable trades.
Here are two beginner-friendly strategies for trading stocks and gaining experience with options.
Disclaimer: I recommend that you learn how options work before using these strategies. If you don’t know what you’re doing, you could incur infinite risk.
Long-Term Call Options: Increase Buying Power and Leverage
Buying call options with a long-term expiration date may allow you to profit from upward price movements of the underlying stock.
If you’re new to options, these are the components of buying a call stock option:
- Asset – The symbol representing the underlying stock shares (i.e., NFLX for Netflix)
- Strike Price – The minimum underlying share price required to exercise your option
- Contract Type – Buying a call indicates you are betting the stock price will exceed the strike price by expiration.
- Exercise – You can exercise the call option if the stock price is at or above the strike price (also known as in-the-money, or ITM).
- Assignment – Assigning the legal obligation to an option seller, who must forfeit 100 shares per contract assigned. It is randomly assigned to one options contract seller when you exercise.
- Option Buyer – You who has the option, but is not required, to exercise the contract before its expiration.
- Option Seller – Obligated to sell 100 shares at the strike price per option contract, no matter how far in the money (ITM) it is.
- Expiration date – The last day that the contract is valid. Out of the money (OTM) options are worthless at expiration, and you lose the premium you paid.
- Premium – The cost to acquire the contract. May increase or decrease depending on how likely the option will expire in the money by expiration.
Suppose you pay a premium to buy a call with a $100 strike price and a 1-year expiration. If the underlying stock price exceeds $100, you can exercise the option and buy 100 shares at $100. To calculate profitability, use this equation:
Profit = Gains – Losses
Profit = 100 x ( ( Current Stock Value – Strike Price )* – Option Premium)
*(Current Stock Value – Strike Price) only applies if the option is assigned
Maximum Profit = Infinite*
Maximum Loss = Option Premium
*Your profit potential is unlimited.
Furthermore, options cost much less than the underlying stock. Buying 100 shares of a stock at $100 would cost $10,000 (100 shares * $100 per share). If you buy a call option with a $20 premium for 100 shares, you’d be paying $2,000 (100 shares * $20 per share).
You can also do what’s known as leverage. For example, $10,000 worth of calls at a $20 premium would reflect the price movement of 500 shares. While you wouldn’t be able to buy 500 shares outright, you can still earn the profits of 500 shares of stock.
Note that if the underlying stock does not move in your favor, the option will lose value. If the option doesn’t expire above the strike price, the contract will be worthless. You give up your entire premium, which is the most you can lose.
If you can’t afford to buy 100 shares at the strike price, you can sell the option before expiration. You may also sell early for profit, depending on the size and speed of the underlying stock’s price movement.
Otherwise, you can execute the option early and buy 100 shares at the strike price. The difference between the strike price and the actual stock price is your profit.
Short-Term Put Options: Get Paid to Buy Stocks?!
Selling puts are another short-term strategy you can use to buy stocks. If you sell a put, someone else pays you a premium to unload their shares if it drops below the strike price.
If you’re new to options, these are the components of selling a put stock option:
- Asset – The symbol representing the underlying stock shares (i.e., NFLX for Netflix)
- Strike Price – The maximum share price required for someone to exercise the option
- Contract Type – Selling a put indicates you are betting the stock price will not cross below the strike price by expiration
- Exercise – The buyer can exercise the call option if the stock price is at or below the strike price (in-the-money for put options)
- Assignment – Assigning the legal obligation to an option seller, who must purchase 100 shares per contract assigned. You may be randomly assigned when someone exercises early.
- Option Buyer – Has the option, but is not required, to exercise the contract before its expiration.
- Option Seller – You, who is legally obligated to pay the strike price for 100 stock shares per contract, no matter how far in the money (ITM) it is.
- Expiration date – The last day that the contract is valid. Out of the money (OTM) options are worthless at expiration, and you retain the entire premium.
- Premium – The cost to acquire the contract. May increase or decrease depending on how likely the option will expire in the money by expiration.
Suppose you sell a $95 put option for a $100 stock for a $5 premium, expiring at the end of the week. You keep the $500 premium ($5 * 100 shares) regardless of whether the put expires below the strike price. You only buy the 100 shares at $95 if the stock dips below that price (in the money). To calculate profitability, use this equation:
Profit = Gains – Losses
Profit = 100 x ( Option Premium + ( Current Stock Value – Strike Price )* )
*(Current Stock Value – Strike Price) only applies if the option is assigned
Maximum Profit = Option Premium
Maximum Loss = 100 x ( Option Premium + ( Strike Price – Current Stock Value ) )*
*Maximum loss occurs if the stock hits $0.
If you were going to buy the stock outright anyway, you would’ve paid $100 per share. By selling a put, you could pay $90 per share ($95 strike price – $5 premium) if it expires in the money. Otherwise, you’d make a $500 profit if it expires worthless.
Between making a profit or buying stocks at a discount, it seems like you win either way. But be careful of the negative price movements of the underlying stock.
If the shares drop to $0 in value, you have to buy 100 shares of stock at the strike price. But you assume that risk even with regular stock trading. The chances of it aren’t zero, but still quite slim. You can buy back the put option to cancel out the one you sold if the stock price drops.
If you’re interested in trading with option strategies, WeBull has $0 in options fees.
Conclusion
Investing goes beyond buying and selling stocks. Different strategies may help us make even more profits. Depending on your investment goals, you may employ more advanced trading strategies or simpler ones.
Even so, the effective implementation of new strategies may help us reach our financial goals sooner. Whether you’re looking to retire early or quit your job, learning how to buy stocks the right way will facilitate those goals.
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