How dangerous is trading on the stock market?

What is trading?

In simple terms, trading is the process of buying and selling investments.

The aim of investing is to use a resource (normally money) to try and generate additional income (aka more money) from it.  

You might do this by using your money to back a particular business, in the hope that it might earn a profit, or by purchasing an asset (like real estate) in the belief it can be resold in the future at a higher price 📈

Although all investments must be bought and sold in order to consolidate any earnings, the word trading is often used to imply an aspect of trying to time the market in order to capitalise on short-term fluctuations.

Some ‘day traders’ may even buy and sell investments numerous times over the course of a single given day.

What is the relationship between trading risk and reward?

The most important thing to remember when trading is that your money is at risk, because the value of your investments can go down as well as up.

When evaluating trading options you’ll notice that risk and return tend to be closely linked ⚖️ Low risk investments are usually expected to yield modest, while higher risk investments may be able to deliver greater potential returns.

How to manage risk when trading: portfolio diversification strategy

When we talk about diversifying investments, we’re referring to the process of spreading money across a range of different investments, to reduce exposure to risk from any single asset.

Diversification (or asset allocation) can help to smooth out volatility in the value of your investments, because if one company in the portfolio performs badly, it should only affect a small portion of your overall investment.

There are a number of factors to consider when creating a diversified investment portfolio:

• Geography a variety of countries / financial markets
• Sector different sectors (e.g. technology or environmental)
• Asset Class a mix of shares, bonds and property etc.

What are the types of investments?

There are lots of different investment types available, and choosing between them is highly personal, but a good place to start is by considering how soon you might need to access the money ⏳

If you have a Self Invested Personal Pension (SIPP) then your retirement account will naturally be a long term investment, but you may also have more immediate requirements to think about.

By evaluating trades based on the likely time period involved, and the risk versus potential reward, you can start to hone in on the type of investment choices that may be right for you.

Some common types of investment are stocks/shares, bonds, funds and real estate, so we’ll look at some of these in detail:

Stocks/shares

A share is a fraction of a business. The words ‘stocks’ and ‘shares’ are sometimes used interchangeably, but they're a little different because shares are actually individual units of a company's stock.

When a company sells shares it issues stock, on the stock market, so an investor can buy (and later sell) shares of that stock. Some investing platforms also allow you to purchase ‘fractional shares’ of individual stocks, which are just portions of one share.

Bonds

A bond is like an investment version of an IOU 🤝  With bonds, you are effectively lending money to someone (usually a government or business).

The main difference between a bond and an informal IOU is that bonds will include an agreed interest rate over a set period of time. For this reason, bonds are often considered more predictable than investing in stocks (albeit with a lower return on your investment).

Investment funds (Mutual funds & Index funds)

A fund is a way for investors to effectively pool resources in order to capitalise on the advantages of operating as a group. The main benefit of funds is that they are heavily diversified.

For example, mutual funds are put together by professional fund managers around a theme, such as asset class or risk-level (e.g. technology / environmental or high-growth companies).

Another common type of investment fund is an Exchange Traded Fund (ETF), which is a collection of securities that are indexed against a set financial market (e.g. the FTSE 100 or S&P 500).

Mutual funds are only bought and sold at the end of each day, whereas ETFs are traded on an exchange, like individual stock.

Other investment types

Some other kinds of investment that you might’ve heard about are commodities, options and derivatives, precious metals… and more recently, cryptocurrencies.

When’s the right time to trade?

An old Chinese proverb states “the best time to plant a tree was 20 years ago... the second best time is now.” 🌳

None of us can wind back the clock, but if you’re considering whether to invest, there are a few questions that may help you decide if now is the right time for you to start.

Q1. have you cleared any high-interest debt?

Overdraft fees or credit card interest payments can make it hard to repay your original debt. Before starting to trade, it might be sensible to start with a clean slate by clearing any debts you have.

If you’re juggling multiple debts then paying them off with a single debt consolidation loan can make managing them easier, and you could even reduce the total amount you have to repay by securing a lower rate of interest (the 'Annual Percentage Rate', or APR).

Q2. Have you created an emergency fund?

An emergency fund is a stash of savings that can be quickly accessed to cover living expenses, if the worst should happen 🚨

Your emergency fund can be used to cover unexpected costs like car repairs, or bills which you find yourself unable to pay due to illness, or in the event that you might lose your job.

Before opening an investment account and potentially tying your money up for the long term, consider putting a financial buffer in place for whatever life may throw at you in the short-term.

3. Have you set clear trading goals?

Setting clear objectives will help you decide on the right style of investing for you, and helps determine what success looks like 🎊

There’s no right or wrong way to trade, but the importance of having a defined strategy before you start cannot be overstated!

For example, you might be focused on working towards a down payment on a property, or creating a pot of money for retirement.

How to choose your trading style?

When choosing between different trading styles, your approach should be dictated by your objectives, how involved in the process you want to be, and the amount of money you anticipate investing.

There are lots of ways to trade, ranging from full service brokers to apps that allow you control the process from your mobile phone 📲

When choosing between them, you'll need to consider whether you aim to ‘beat the index’ by actively managing your trades (either directly or via a broker), or if you’re happy to take a more passive approach.

If you plan to be a passive trader, you could use your money to buy an index fund and save yourself a significant amount on the fees you might pay for personalised investment advice.

How to trade

Historically, if you wanted to invest money, you'd need to use a wealth manager or investment broker.

When you open a new brokerage account, an online broker will typically build a picture of your investing style by asking about your goals and risk tolerance.

Full service brokers are equipped to handle most things to do with money. They’re regulated to give investment advice, and can even help you create a full retirement plan. The service they provide is personalised to your needs, but they also tend to charge big fees, and will only take on clients with a high-net-worth 🎩

Discount brokers will provide you with the education and tools to manage your own investments. This can be done either directly or via a robo advisor that can make investment decisions on your behalf using an algorithm. Because the service is less personal, usually minimum deposits will be lower and fees much cheaper.

Simple steps to start trading money

Nowadays, trading is no longer the reserve of the rich! Open Banking technology means that investing is available to everyone.

You can choose from a variety of trading apps that provide an easy-to-use interface, making it easy to manage your portfolio.

You can either invest in a Stocks & Shares ISA (allowing you to invest money tax-free under ISA rules) or a General Investment Account.

Once you've decided on the platform and you're ready to start trading, the process can be broken down into the following steps:

Step.1 Decide how much to invest

Step.2 Decide how frequently to trade

Step.3 Decide which types of investment

What are the charges in trading stocks?

The charges you pay when you trade stocks will depend on the type of investment account you have, and the platform you use to make trades.

If you’re an eligible UK adult and you’ve invested your money into a Stocks & Shares ISA account, you will be entitled to invest your annual allowance of £20,000 without needing to pay tax on profits.

If you’ve traded your money using a General Investment Account (GIA) then you may need to pay Income Tax, Capital Gains Tax, Dividend Tax and Stamp Duty. The amount you pay will be dependent on your income, the amount of profit you earn and whether you buy your shares using an electronic platform or by filling out paper forms.

Trading platform costs and fees

However you trade, there are various platform fees and charges you can expect to pay. Below are the most common costs for trading (though, depending on the platform, not all may apply):

• Platform / technology fees are the costs for building and maintaining whatever website or app you use
• Investment management fees are the costs you pay for advice or management of investment funds
• Monthly subscription charge is the cost for you to have access your platform of choice
• Trade commissions / FX fees are the costs (either a flat fee or percentage) each time you place a buy/sell order

How do I start trading with little money?

Thankfully, these days trading is not solely the reserve of the wealthy. It’s possible to buy low-cost stocks, or regularly trade small amounts via an automated trading app.

Not only does this mean that you don’t even need to think about the process, you can even choose to split your deposits between your savings accounts and any investments that you’ve selected.

How can I start trading with £1,000?

Trading is a very personal subject. There is no one-size-fits-all approach, but if you’re just starting out then investing in a mutual fund might be considered a relatively simple place to start.

These funds are professionally managed, so you may be able to benefit from the experience of people who do this full-time, for a living. Though, always remember that even professionals get things wrong sometimes.

If you’re feeling a little more adventurous then you could begin by trading in bonds or stocks.

If you’re not quite ready to invest yet, consider saving for an emergency fund first with a Cash ISA.

We also have articles on a variety of specific Cash ISA providers and accounts: Coventry Cash ISA, Leeds Building Society Cash ISA, RSB Cash ISA, Barclays Instant Cash ISA, HL Cash ISA, Paragon Cash ISA, Saga Cash ISA, Tesco Cash ISA, Ford Money Cash ISA, Kent Reliance Cash ISA, Metro Bank Cash ISA, Moneybox Cash ISA, Vanguard Cash ISA, Yorkshire Bank Cash ISA, Bank of Scotland Cash ISA, Fidelity Cash ISA, Shawbrook Cash ISA, Britannia Cash ISA, and more.

If you’re ready to start trading, it's super simple with an app like Plum. To learn more about Plum you can check out our website.

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