5 Don’ts for Online Investing

Protect Yourself and Your Dollars

5 Don’ts for Online Investing
May 2, 2014

If you are just starting in the world of online investing, the options and mechanics of trading can be overwhelming. Here are a few perils to avoid:

  1. Don't Abandon Your Plan – Are you a buy-and-hold investor just using online investing to save money in brokerage fees? Then don't try to be a day-trader for a day. Either you are a day trader or you aren't.

    If you are already a day trader, then you should have a trading strategy in place. Our only advice to you is to arrive at that strategy through careful research and apply it with discipline. Chasing a hot stock on impulse is a bit like chasing a runaway freight train – you probably cannot catch it, and if you do, it will probably be right before it crashes. The smart people got off the train earlier.

  2. Don't Misunderstand Orders – It is important that you understand the types of orders before you use them. Common types are:
    • Market Order – An instruction to buy at current market price. Current market price means the price when your trade is executed, not when you hit the button on your screen. The price may rise or fall significantly in the interim.

      Novices can panic watching a rising stock, thinking the "buy" button didn't take – and hit buy again, doubling an eventually unprofitable order.

    • Limit Order – An instruction to buy or sell when a security reaches a specific price limit (upper limit for buy, lower limit for sell). You are guaranteed the price you set.

      This dampens both losses and gains, but it does not guarantee that you will have a willing buyer or seller for that price.

      Limit orders generally have higher transaction fees than market orders.

    • Stop-Loss Order – An instruction to sell when the price reaches a specific limit, in order to cut losses or maintain a minimum profit. The difference in a stop-loss order and a sell limit order is that stop-loss orders become market orders when executed, with the same volatility issue as any market order.

      That means it is possible, perhaps even likely on a sinking stock, that your actual executed sell price will be below that of the stop-loss order. The guarantee of price is why limit orders are more expensive.

      A stop-limit order incorporates the guarantee of a limit into a stop order, but at a higher transaction fee.
  3. The default assumption is a market order. If you want something different, learn the many types of orders and do not be caught by surprise with your returns.

  4. Don't Make Too Many Transactions – Avoid the adrenaline of chasing hot tips or overreacting to market fluctuations with excessive buying and selling. You can lose track of your trades and easily incur significant losses while unbalancing your portfolio and incurring excessive transaction fees.

  5. Don't Ignore Costs – Fees can add up quickly with multiple trades. Also, remember the tax ramifications. Profits on holdings of less than a year are generally considered short-term gains and are taxed as regular income instead of the lower capital gains rate.

  6. Don't Lose Track of Risk – It is important to properly understand the inherent risks in investing and not go past your tolerance or expertise. For example, buying on margin (borrowing from a broker to buy securities) can be useful but extremely dangerous if you have no experience or cannot properly balance the risk with the associated reward.

The common threads are immediacy and temptation – without focus and discipline, online investing can feel more like gambling than investing. If you don't make plans and stick to them, or you succumb to fantasies about "the big score," gambling is exactly what you will be doing.

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