Ways To Get Into The Market
Today's market was red hot! For those who haven't gotten into trading shares yet, there will probably be a small dip later this week or early next week after today's rally, so do take advantage of that buying opportunity.There are a variety of ways you can get involved into the stock market. A great starting point would be to open up a trading account with your bank. I suggest starting with your bank's discount brokerage before going to third parties or standalone discount brokers (such as Questrade). Once you have built some confidence and know generally what you're doing, it would be a good idea to seek standalone discount brokers because their commissions are often cheaper (in exchange for less hand-holding).
Basically, you can do three types of transactions with
stocks: 1) buy shares, 2) short sell shares, and 3) options. Actually...
"basically" is a little misleading once you get to the third one but
I will try to make it as easy as possible.
Buying shares:
You do exactly just that, you purchase shares on the open
market such as the TSX or NYSE through your broker using their online
interface. Once the price has either gained enough grounds or dropped below
your loss tolerance/threshold, you would then sell it on the open market
through your broker. Obviously your goal would be to sell it for more than what
you bought it for, less commissions.
Short selling shares (Make more $ as it drops!):
What happens here is that the broker will lend you shares to
sell immediately on the open market at current price, and then when you want to
close out your position you simply buy the same amount of shares on the open
market to cover what they have lent you. The idea is to buy later at a lower
price than what you have sold the borrowed shares at. This type of trade is
very risky because there is no ceiling theoretically as to how high the stock
can rise to, therefore your potential loss is unlimited.
Options on shares:
In this case you are buying or selling an option on a
company's stock. To complicate matters there are two types of options that can
be bought and sold, they are 1) Call options and 2) Put options.
Buying a Call option means you are buying the right
to purchase shares for a specified price within a specified period of time.
That specified price is named the exercise price, and it is what you can buy
shares at no matter what the market price turns out to be later.
Selling a Call option, also called writing a Call option,
means you are selling an option to someone so that he or she can buy shares in
the future for a specified price within a specified period of time. It is the
flip side to the above "buying a Call option". Note that your losses
CAN be unlimited if you don't currently own the shares, because if the buyer of
your option exercises their right you will have to give them the shares in
return for the exercise price. Since share prices can rise to no end and you
will be buying shares on the open market, that opens you up to unlimited
losses. The technical terms if you're doing some Googling, are Naked Call for
ones where you don't currently hold shares, and Covered Call for ones where you
already own the shares. By selling a Call option, you have the obligation to
sell shares.
Buying a Put option means you are buying the right
to sell a company's shares, to the seller of the Put option, for a
specified price within a specified period of time. So if the stock price dips,
you can still sell it for whatever the exercise price is because you paid the
seller of the option in order to have this right.
Selling a Put option means you are on the other side of the
above transaction. So you get paid upfront a premium for the option, but you
have the obligation to buy the shares from the purchaser of the option
if he or she decides to exercise it in the future. Your losses are capped
because the most you will lose when they exercise the option is simply
(Exercise Price - Premium Received per share) x # of shares. BTW, yes I did
leave out opportunity cost since you could've gained by being on the other side
of the transaction, but let's not go there... these articles are meant to be
easier to understand for most folks!
I know the third one is a bit complicated and actually I
would advise against using options until you have become familiar with trading
shares, it's easy to lose money with options! The good news is though, if you
bought an option and didn't use it by the time it expires, that loss is a
capital loss for Canadian tax purposes.
Happy investing everyone!
Happy investing everyone!
-TT
