Some finance questions. What's daytrading? what are options? What are brokerage costs? When to sell?

Question

Yep, a lot of questions unanswered.

I learned about mutual funds, but I've been hearing a lot of bad stuff about them lately. I wonder what are the costs of just getting a broker or a brokerage service. If I wanted to invest 2 grand in some stocks just to practice, how much would it cost me to buy and sell as opposed to like expense ratios and all that?

what are stock options?

My finance teacher taught us how to monitor stuff, but she never taught us anything about selling. When do small cap stocks peak? When do you give up on them?

What is daytrading? Is it costly because of all the brokerage fees?

What are some good cheap brokerage services to start with?

Answer 1

Daytrading is what the name implies, trading stocks during the course of the day.  Daytraders usually do not hold many positions (either long or short) over the end of business and look to close out their positions by the end of the day.  Daytraders usually trade based on a stock's technical analysis and try to capture daily movements in the stock's price.  Because daytrading involves many trades, daytraders usually use an online brokerage service with the lowest commissions per trade.  There are some such services that only charge a few dollars per trade because of the volume.  Even firms like Fidelity, Etrade and Schwab only charge about $10 per trade and there are some that charge less.

Regular "full service" brokerage firms, like Merrill Lynch, usually charge over $100 per trade if you use a broker (instead of their online service).  Average mutual funds typically charge expense fees of between 0.50% (for the cheapest funds like Vanguard) to over 1% of your account balance each year.  Load funds can charge up to 5.75% of your initial mutual fund purchase (which typically is just a commission that goes to the distributing broker).

Small cap stocks come in and out of favor.  They had quite a run after the dot.com crash and many pros expected large caps to start to outperform small caps in the last 2 years.   The theory is that small caps have a more difficult time getting credit than large caps during credit contractions.   You could compare the indices that represent large cap (the S&P 500) versus small caps (the Russell 2000) to compare relative value of the two.  You can also look at the chart of these indices.  Like I said, the period of outperformance is cyclical, but it is difficult to call the turn when one investors will start to favor one over the other.  Better to be invested in both.  However, I have read several articles (mutual fund manager and Forbes columnist David Dremen is a proponent) that say that small caps always outperform large caps over a longer term (especially small cap value stocks).(The growth versus value argument is a separate one).  There are some great small cap mutual funds, like the Royce Funds, that have performed in all types of markets for long periods.

When to sell is the most difficult decision in investing.  There are always plenty of stocks to buy even in the worst of times.  In almost any economic time, there is a demand for some goods and services and some part of the world is usually growing (the exception would be a worldwide recession).  The hard part is determining when an investment is not working out and you don't want to give it any more time, or when it's time to take a profit.  Most of us are not good at judging the actual earnings growth within the company and to know when the growth of a company is fully priced in the stock.  It helps to look at the stock chart to see if the stock is leveling off or starting to turn down.  Of course, some stocks pause or pullback before resuming their upward trend.  Therefore, you have to use technical analysis along with the fundamentals to see if the growth is slowing.  Remember the stock market anticipates events so by the time a company reports that its growth is slowing, the stock price will already have started downward.  You have to read the company's earnings reports to see what they say about future growth.  They sometimes mentions statistics like "backlog" which tells you how much future sales they already have lined up.  Also, a company's "profit margin" should be growing as sales expand.  You can also compare the company's expected future price to earnings ratio versus its earning growth. A general rule is that you should not pay (i.e. buy a stock) for a p/e ratio of more than 1 times a company's future earnings growth rate.  (in other words, if a company is growing earnings at 40% each year and will maintain that growth rate, then don't pay more than a p/e multiple of 40 for the stock.  At such a p/e ratio, the market is telling you that the growth in earnings is already priced into the stock price.  Some people pay up to 2 times the growth rate for company's with exceptionally high growth rates and no competitors, but because of the law of large numbers, growth rates have to decrease as the company gets larger.)

Above all, if you buy a stock that turns out to be a good investment, don't get greedy and think that it will always go up in value.  Even the best companies' stocks level off after large movements.  Sell part of your position on the way up and don't worry about paying taxes or brokerage commissions (better to have a profit then a loss).  Don't worry if the stock continues to rise.  If you've done your homework, then you should start to recognize when the stock is losing some of its steam.  Nowadays, there is almost no such thing as "buy and hold."  Almost ever great stock has had a period where it leveled off and did nothing (so-called digesting its gains) sometimes for years, or started a long gradual decline.  Mostly, because when a company is starting to perform, it draws the attention of the investment community and they buy the stock causing the price to rise.  At some point, investors capture their gains and move on to the next opportunity.  Many people get "caught" buying expensive stocks that have already peaked and ride them back down.  This can happen even though the company continues to report good earnings growth.  When a stock does not go up and stay up on a good earnings report, it means that this news is already factored in to the stock price and no new buyers are being attracted.  A stock needs new buyers to push the price up.  Like I said, it is the most difficult thing to judge.  Good luck.

Answer 2

Start by reading "Stock Investing For Dummies."  Its a good introduction.