Last Updated on 3 November, 2022 by Samuelsson
How Do Trades Work?
Financial trading is a highly specialized field, but a lot of people think they can succeed in it without adequate knowledge. Many just dabble into it after watching a few YouTube videos without understanding how trades work. As a trader, ever bothered to know how trades work?
In the financial markets, trades work in a reverse-auction manner: potential sellers submit their ask prices (sell limit orders), and potential buyers submit their bid prices (buy limit orders). A trade occurs either when an active buyer accepts (market buy order) the ask price of a potential seller or an active seller takes (market sell order) the bid price of a potential buyer.
In this post, we will take a look at the following subheadings:
- What is Trading?
- How do you do trades?
- How do you make money from trading?
- How do you trade for beginners?
- Is being a trader worth it?
What is trading?
Trading is a term used in the financial markets to refer to the buying and selling of financial instruments. Some of the most commonly traded securities are foreign exchange (Forex), stocks, commodities futures, interest rates, bonds, ETFs, index funds, etc.
A trader is an individual involved in the buying and selling of financial securities. A trader can buy or sell for themselves or on behalf of another individual. The notable difference between trading and investing is the period of holding the security.
How do trades work
Trades work like an auction but in a reverse manner. Potential sellers submit their ask prices (sell limit orders), and potential buyers submit their bid prices (buy limit orders). A trade transaction occurs either when an active buyer accepts (market buy order) the ask price of a potential seller or an active seller takes (market sell order) the bid price of a potential buyer.
If buyers outnumber sellers, they may be willing to raise their bids in order to acquire the stock. Sellers will, therefore, ask higher prices for it, ratcheting the price up. the opposite occurs when sellers outnumber buyers.
How do you do trade?
When trading, you buy a security (go long) in hopes that the price will increase over a period. You profit when price increases and incur a loss when it declines. Another way around it is when you sell a security (go short) in hopes that the price will decrease. You profit when the price decrease and incur a loss if it increases.
But before you start trading, you need to have an account with a broker. The broker you choose would depend on what you want to trade. Some brokers may offer you stocks, while others have multiple securities offerings.
You may be asking the question: how do you trade for beginners?
Below are some steps to take to start online trading as a beginner:
- Find a broker. Your first step to online trading is to find a broker. They are over a thousand brokers online, making it challenging for beginners. However, there are criteria a broker needs to meet in addition to your requirements.
Some of the things you must look out for are: the minimum balance, commissions, swap fees, trade execution speed, customer service, payment methods, and how fast and easy to withdraw your funds.
You should not be in a hurry to select a broker. You can check reviews by other traders to have a better judgment about your preferred broker.
- Open a trading account. The next step is to open a trading account. The steps are usually straightforward for most brokers. You can create an account using your email address by visiting the broker’s website.
You may be required to provide some documents for verification purposes. After verification, your account will be ready for the next step.
- Start with demo trading. Now that you have verified your account, you might want to add money and start trading outright. While there’s no one-size-fits-all rule on what to do after your account verification, you should open a demo account to get the hang of how things work in the market you want to trade and also to understand your broker’s platform. Since this is a virtual account, it is safe and risk-free as you would not lose your money when you make mistakes.
- Fund your account. After you have improved your skills and developed a clear strategy. You are now ready to start trading with real money. The most important thing is having a strategy and a good trading plan. In addition to having a good trading plan, discipline is one key to being successful or not.
Your trading plan is your rule book and must be adhered to always and reviewed periodically.
- Go live. You can now start buying and selling securities on your trading account.
How do you make money from trading?
You make money from trading when you buy securities at a lower price and sell it at a higher price. To make it more understandable, let’s look at this example below.
Suppose you did your research and found a potential trade opportunity on a stock (Profit LTD) and decided to buy 100 shares of the stock at $2.50 per share. After two weeks, Profit LTD’s share price soar higher to $10.50 after experiencing a breakthrough in products innovation.
You will be very happy because you got in when the share price was $2.50 and sold at $10.50 to lock in your profit. Let’s calculate how much you made after selling the shares at $10.50. The calculation of his profit is shown below.
Buy price is $2.50
The amount of shares bought is 100 shares
Initial Investment = buy price * amount of shares.
Initial Investment = $2.50 * 100 shares = $250
After two weeks, the new price = $10.50/share.
New Value = $10.50 * 100 shares = $1050
Profit is calculated as below:
Final Investment – Initial Investment,
$1050 – $250 = $800
So, you just made $800, more than 3x your initial investment.
The above is just a hypothetical trade. In real life, you have to consider the fees you’re paying for each transaction you’re making because this will affect the final amount you get as profit. Moreover, not all trades would end in a profit.
Is being a trader worth it?
Many beginner traders might ask this question after losing some money in the market. But the industry has seen quite many traders who made fortunes.
Of course, being a trader is worth it, but you must know that trading is not a path to overnight success. Success is gained from continuous education and how you apply the knowledge in real life.