8 Things Every Online Investor Should Know
The resources on this page have been designed to help you develop an understanding of how to stay safe when investing online.
- Start small.
If you are new to online investing, don't put your entire life savings into an online account. Start with a smaller sum, which will be easier to handle and keep track of. Once you feel confident, you can then decide to add more money to your online account.
- Stay diversified.
Once online, many investors tend to concentrate on stocks, specifically large-cap domestic stocks. While these stocks should make up part of your portfolio, they shouldn't be ALL of it! Take into account your time horizon and risk tolerance to develop a well-balanced portfolio of stocks, bonds, and cash.
- Don't bail on mutual funds.
Most investors are in mutual funds for a good reason. They don't have the expertise to make their own investments calls on individual stocks. They also are too preoccupied by work, family and other concerns to spend every minute watching the market. So keep your mutual funds; it probably is an unwise move for you to cash out your long-term fund holdings so that you can start "playing the market" in individual stocks!
- Costs may not always be obvious.
Even if online brokerage costs are lower than those of full-service brokers, they can still add up, particularly if you do a lot of buying and selling. Online brokerages firms also impose a number of other fees and charges that you should study closely. The federal capital gains tax is also something with which you must reckon. Before you start buying and selling stocks or mutual funds online on a large scale, you should give careful thought to what the tax bite would be as a result of such trading.
- Make orders work for you.
If you are going to do your own investing online, you need to learn how to use the tools available to avoid potentially steep losses and to buy or sell a stock at attractive prices. Here are three "orders" that you should use to your advantage:
A MARKET order is an instruction to buy or sell a specified amount of a stock (or other security) at the current market price. The advantage of a market order is you are almost always guaranteed your order will be executed - as long as there are willing buyers and sellers. Depending on your firm's commission structure, a market order may also be less expensive than a limit order.
A LIMIT order allows you to avoid buying or selling a stock at a price higher or lower than what you specify. A limit order is an order to buy or sell a security at a specific price. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. By contrast, a market order only guarantees you the best available price -- not the limit order's specified price.
A STOP-LOSS order sets a sell price for a broker. When the price of the stock drops below this level, it automatically is sold. Also: Take the time to learn about "stop orders," "day orders" and "good-till-cancelled" orders
- Mind those market orders.
Limit orders are often used to guarantee that an investor will not pay over a certain dollar level for a stock. If no limit is placed, the trade is considered to be a market order. Placing a market order means you won't necessarily get the price you see when you buy or sell online. Here's how that works: an investor places an order for a fast-moving stock at $10 share price, but the order does not reach the market until the stock's price is at $15 a share.
- Problems are inevitable.
Trading online is not foolproof. There will be times when you can't access your account. You could be away from your computer when the market makes a major move. Your Internet connection could be down. The online brokerage firm's server could crash due to heavy trading, unexpected software glitches or a natural calamity. Know about the firm's alternative trading options. This could include automated telephone trading or calling a broker.
- Information is power.
If you are going to buy and sell individual stocks online, it is your duty to keep as well informed as possible about what is going on with the company in question. Don't just settle for the hype about hot stocks! Go to the company's Web site and download its prospectus. Check out the company's publicly available filings through the U.S. Securities and Exchange Commission's EDGAR system. Take advantage of free services that allow you to get automatic e-mail messages whenever there is news about your stock.
Myth: I am going to make a killing online.
Reality: Online investing isn't a surefire way to get rich. In fact, research shows that the vast majority of day traders - the handful of online stock traders who are the busiest - lose money. Though online investing isn't for everybody, it can be a powerful tool for investors who are disciplined about research, make carefully reasoned decisions and maintain a balanced portfolio.
Myth: If I trade online, I can get in on all those high flying IPO's!
Reality: Initial public offerings consist of the shares of publicly traded companies that are being offered for the first time to investors. Because the price often rises rapidly in early trading, they are popular with many investors. Even though some online brokers are taking steps to get more IPO shares to individual investors, many investors will find it difficult or impossible to "get in on" a hot IPO in which they are interested. This is really a function of supply and demand -- a relatively small number of IPO shares and a big demand on the part of interested investors.
Myth: The second I execute this trade, my shares will be purchased.
Reality: Just because you click buy doesn't mean that your stock or mutual fund will be purchased at or even anywhere near that particular moment in time.
Sometimes -- particularly during heavy trading periods in the markets and as a result of computer problems -- your online order will be processed minutes or even hours later.
As a result, an order for stock at $10 per share could go up (or down) by the time your purchase is actually executed.
A limit order, which can be used to set a ceiling for what an investor is willing to pay for a stock, can be used to minimize this kind of uncertainty. Additionally, investors may want to put a stop-loss order in place. A stop-loss order sets a sell price for a broker. When the security's price drops below this level, it is automatically sold.
Myth: With my online account, I'll be able to buy and sell stocks at any hour of the day.
Reality: It's true that you can access your online investment account at any hour. You can even place buy/sell orders and receive confirmations at 3 a.m. This does not mean, however, that those trades are executed immediately. Any trades you institute after market hours will not be carried out until the market opens again.