Trading shares for beginners: The most important things you should know before buying stocks.

Stock trading is not only about buying and selling equities (stocks). In fact, learning about trading strategies, algos, and trading is the easiest part. A lot of beginner traders want to learn this part, forgetting that stock trading involves much more complicated things, like stock selection, fundamental and technical analysis, risk and portfolio management. These things are important because it's important to choose great stocks that can rebound fast if they start falling, stocks that can bring longer-term value to their owner, and you should also think about generating longer-term positive returns. That's why I decided to cover the most important things when it comes to stock trading, beyond simple stock trading strategies and order execution.

First step. Finding the right brokerage company.

The first thing beginner traders should do is choose the right brokerage company. Individual investors cannot buy shares directly, they need an intermediary, which is a brokerage company, to open an account, deposit money, and leave orders to their broker to trade shares. They can leave orders electronically, through the trading terminal, or via a phone call to their broker. Unfortunately, there are a lot of scam companies that want your money without providing you real market access. To make sure you are dealing with the right and reputable brokerage company, you need to check the broker. If you are opening the account with a US broker, you should check them via the FINRA BrokerCheck page, where you have to input the brokerage company name and see if it's a reputable brokerage company. You can see where it operates, if it has some violations, and its management structure. If you are dealing with a European brokerage company, you can check the company via the ESMA website, where you can find investment firms authorized under MiFID II across the EU.

Apart from being registered with the financial authority, your brokerage company should have a reputable bank custodian. A custodian plays a critical role in safeguarding client assets and ensuring the operational integrity of the brokerage. The bank custodian should not be registered in the offshore zone and should have clear and transparent reports. Ideally, the bank custodian should be registered under the US authorities.

Second step. Open an account and deposit funds.

The next step is to open an account with your selected brokerage company. Fill out all the forms provided by the brokerage company and pass the security checks. Then deposit money to the brokerage company from your bank account. Nowadays, brokerage companies provide different options for depositing money, including Bank Wire, Direct ACH Transfer, from the Wise Balance, Online Bill Pay, or by mailing a check. After depositing money, wait a few days until the money is credited to your brokerage account, and you are ready to proceed to the next step.

Third step. Building your strategy.

Before starting trading stocks, you need to understand what your trading strategy is. This is important because your strategy defines your trading style. To come up with your trading strategy, you need to understand your risk appetite. For example, risk-seeking investors are willing to bear higher risk, expecting to get higher returns. These are usually younger traders/investors who buy highly volatile stocks, whereas risk-averse investors prefer less volatile stocks and often combine stocks with other financial instruments such as bonds or income stocks (shares that have high dividend yield). Then you should define your stress level, the level of risk you are willing to take.

You should know how to set a stop-loss and take-profit to know in advance when you will exit the position if the stock starts falling or rising. Also, your risk appetite defines your holding period, which is also an important part of your strategy. For example, risk-seeking investors can hold highly volatile instruments that can rise and fall fast, and their holding period can be shorter than that of risk-averse investors, who need more time before their assets start showing some returns.

Fourth step. Stock selection.

After understanding your strategy, it's time to dive into stock selection. Choosing the right stock is important to generate positive returns over time. Sometimes a stock can fall rapidly but has higher chances of rising again if it's a value stock (a stock with strong fundamentals). To choose such a stock, you need to undertake a company analysis (stock issuer analysis) and equity valuation to calculate the stock's fair value. While company analysis helps you find strong shares, equity valuation helps you understand if the stock is currently trading cheap (undervalued) or expensive (overvalued). Both company analysis and equity valuation are part of fundamental analysis.

Company analysis includes reading management letters to understand what their company vision is, financial statements analysis and forecasts to see what the company perspectives are and if they match your expectations, financial ratios analysis to see if the company is stronger than its closest peers (competing companies), stress testing to see how different factors (rising cost of money, company strategy shifts) can affect the stock price.

Equity valuation includes stock fair value calculation using different equity valuation models like the DCF, the DDM, or the Price-Income model. This is done to calculate the stock's fair price based on your forecasts. If the stock fair value (target price) is above its current market price, the stock is cheap (undervalued). If the target price is below its current market price, the stock is expensive (overvalued), and you can wait before buying the share. You should regularly do fundamental analysis (quarterly) because companies post their financial results every quarter, and each company has different reporting periods.

Fifth step. Portfolio management. Minimize your portfolio's loss, given your expected return.

By now you should already know how to find great shares that can rebound fast and look strong fundamentally—companies that look stronger than closest peers. I would suggest choosing 6-10 stocks (different companies) for your first portfolio. You can choose more stocks, but remember, if you take more stocks, it may take a lot of time to do fundamental analysis because you have to regularly check your shares. After choosing the right stocks tailored to your risk appetite, it's time to see how those stocks would “live” together in the portfolio.

A good balance of risk and return will smooth your portfolio risk while generating good portfolio return over the longer term. You should know exactly what the weight of each stock in your portfolio should be (based on stock individual parameters such as volatility and trading irregularities) in order to achieve the minimum possible portfolio risk while generating your desired return. You can use the Markowitz model to find the good balance of stock weights in your portfolio. If you don't have time to manually calculate stock weights, you can use different web-based apps that can help you maximize your portfolio return and minimize the risk. For example, the Diversset that uses the Markowitz model to build you an efficient investment portfolio. But not only that, the Diversset also helps you find stocks tailored to your risk appetite and combines stocks in your portfolio in such a way as to minimize the portfolio's loss while also maximizing its expected return (using the AI algorithm for return maximization). It tells you the exact weight of each asset that should be in your investment portfolio to achieve this result. But remember, since company fundamentals and market conditions change regularly, no portfolio management models can give you accurate results, only the approximate picture of what your portfolio's risk and return could be at the current moment. If you are interested in building your first efficient investment portfolio manually you can watch a video on How To Build An Efficient Portfolio.

Sixth step. Risk management.

After knowing the percentages of different stocks in your investment portfolio, it's time for some risk management. There are different risk management models that can help you with that. For example, the Value-At-Risk or the VAR model. VAR tells you what can be your maximum portfolio loss for the period given a high confidence level of 95% or 99%. VAR can be calculated both for a single stock and for a portfolio of assets. This is important to know because when you know what your portfolio's loss can be, you can decide if this portfolio is appropriate for you or if you should find other stocks that will generate lower possible loss for your investment portfolio.

Another important risk management model is the Monte Carlo simulation. This simulation modulates your portfolio's behavior for ten thousand days (you can set it for fewer days, but it will be less accurate) and then assigns a range of your portfolio's loss exceeding, say, 5%, 10%, and 20%. The difference from the VAR is that the VAR assigns the maximum loss, while the Monte Carlo simulation assigns different loss/return ranges for your investment portfolio, and you can see loss probabilities and decide if this portfolio is right for you or if you should choose other stocks that are better tailored for your expected return/loss.

Seventh step. Buying shares.

Finally, we are approaching the stock trading. As you can see, this is not the most important thing in the process, but there are a few important things you should know to make efficient trades. If you are using the trade terminal provided by your brokerage company, you can use different trading algos. These algos are there to deliver you the best execution by minimizing your trading costs while providing you with the best price at the time of trading. After choosing your trading algo, it's time to learn to set stop-loss and take-profit in the trading terminal. It's not necessary, especially if you believe in the company and are holding for the longer term, but if you are an intraday trader and are interested in shorter-term trades, you can set SL and TP to know exactly when you will exit your trade. You should also learn about different order types to know how to trade shares and how transactions are settled.

Also, use technical analysis to understand your stock's trading parameters, like volatility, gaps, volumes, and trend direction. This knowledge can help you shape your trading strategy and give you valuable understanding of whether you should trade shares intraday or better choose a longer-term holding strategy. Also, you can use different trading indicators and learn about Japanese candlestick patterns. This information will help you understand the strength of the trend and when the trend may change.

Eighth step. Portfolio restructuring.

Company fundamentals change regularly, and so do market conditions (country GDP, inflation, cost of money), this all affects stock prices. Some become more volatile, which affects your portfolio's risk/return. That's why you should regularly check individual stocks and market conditions, and if you see that stocks are becoming more volatile or company fundamentals change, it may be time to restructure your portfolio and get rid of some stocks, replacing them with better equities or maybe changing the stock weights.

Also, you can use the Sharpe ratio to understand if you still have the best portfolio among similar portfolios. If you have the highest Sharpe ratio in comparison to similar portfolios, it means that your portfolio is still strong. A declining Sharpe ratio, or a ratio that is lower than similar portfolios, may indicate that your portfolio is not efficient anymore and that there are better portfolios that can generate higher return with the same amount of risk, and it may be a good idea to restructure your portfolio.

Trading shares for beginners. Final notes.

As you can see, trading stocks is not only about buying and selling shares. It involves many things starting from brokerage company selection and ending with risk and portfolio management. If you follow my recommendations and follow the steps listed in this article, you can have higher confidence and can generate positive returns over the longer term. But don't forget to keep a close eye on company fundamentals, market conditions, and regularly undertake fundamental analysis and manage risk properly. Thank you for reading the article.