When you are looking to purchase shares of stock, there are a few ways to do that. Whether you are talking to your broker, or doing the trading on-line these same terms apply.
The first term is buying at Market. This means you are willing to pay the current price of the stock, as determined by current demand. If you really want to purchase shares at any price and right now, this is the way to do it. You are relinquishing control to the market. You broker, or program will snatch up the shares you desire at the current market price. For example, you want to buy 200 shares of XYZ at market price. When you were initially looking at the company, doing your Due Diligence, the price was at 5 dollars. That seemed like a good entry point, so the next day you put in your Market order. Unknown to you, a few other people saw the same stock and also placed orders. The price was driven up to 7.50, so that is where you purchased your shares. Total cost, $7.50 X 200 shares plus transaction fee of $10 = $1510. If you really wanted the stock, and $7.50 also fit into your model of a good price, you are the proud owner of 200 shares. If you didn’t want to spend $7.50, too bad, you still own the shares. How could you have avoided this?
The next term is called a Limit order. This works similar to the market order, in that you are still saying you want the 200 shares, but you are calling the price. If you put in the order and said 200 shares Limit $5 per share, then $5 is the maximum price you will pay. You are limiting the price. If the price has risen, you will not get the shares. You can also make this have a defined term by saying the order is good until you cancel it, or until the end of the day. You can define the time line you are willing to enact that trade. With the limit order, your cost will be $5 X 200 shares plus transaction fee of $10 = $1010. However, the trade may never take place if the stock doesn’t see the $5 price again. On the other side, if the price is below $5 when you place the order, you will get the lower price and the total cost will be lower. Limit doesn’t say, “I will pay $5.” It sets the maximum you are willing to pay.
The flip side of this is, of course, selling stocks. You must first realize that there are two categories of sells. The first is short term and the second is long term. This is strictly a factor of the time you hold a stock. The dividing line is 365 days. The difference between the two is the tax rate of your gain. If you keep a stock less than a year, the gain (assuming you have a gain) gets taxed at your current bracket. If you hold a stock for more than a year it gets taxed at around 15{5579a4f790a1703f03f9e8973666cfa8cd3511cf74edb6fd520545ba0854a635}. This was put in place to add stability to the market. If people didn’t have this tax rate in the back of their mind, the market would be a lot more unstable. For more on short and long term gains check out This
Another thing you need to keep in mind is the fees that are involved with your buying and selling. If you are a small time investor, especially, this can whack you pretty good. For this discussion, I’m going to take taxes out of the equation. If you buy stock A for $10 a share, and get 10 shares; your total cost is $100. (I realize this is a low number, but it is for illustration purposes only.) Now you add the trade price; on E-trade that is $12.99. So instead of $10 per share, you have paid $11.29 per share.
Cost Breakdown
$100/10 shares = $10 per share
($100 + 12.99)/10 shares = $11.29 Per share
So here you are a year later deciding to sell this stock, and the price is $12.50 per share. That is a 25{5579a4f790a1703f03f9e8973666cfa8cd3511cf74edb6fd520545ba0854a635} gain. Nice trade, smart move. Or is it?
When you sell the stock, you get hit with the same trade cost of $12.99. So we actually paid $11.29 per share, so the gain is not $2.50 but only $1.21 per share. When you add in the cost of the sale, it is even lower. Check out the table.
Buy price
($100 + 12.99)/10 shares = $11.29 Per share
Sell Price
($125 – 12.99/10 Shares = $11.20 per share
Gain/Loss
$112 – $112.90 = – $.90
So after a year you have $99.10 instead of $100. This is obviously an exaggerated case. But even if you would add another 90 shares and say you bought 100 shares, the impact dollar wise is still the same. You r profits are minimized by the cost of the trades. The only difference is in the percentages. In the “buy” portion, the added trade cost makes the price per share $10.13 ($1012.99/100 = 10.129) and likewise on the sell. The sale price is $12.37 per share. The profit in the 100 share scenario is $224.01.
This is a pretty simple concept, but one that people can overlook when they are trying to make “quick cash.” Last year I paid $467 in trade fees. If I had a small portfolio, that could be a huge percentage, and could wipe out any profits I might have made.
