To Trade or not to Trade…
Other articles in this series:
Part 1: No Interest?
Part 2: To Trade or not to Trade…
Part 3: Choosing Shares
Part 4: Turkish Mutual Funds
Part 5: Interesting Deposits
Part 6: Currency Trading
Part 7: Comparing Investments
To Trade or not to Trade…
Although the Turkish Central Bank did not make a further cut in interest rates at their last meeting for 2009 on December 17th, they did indicate that the current low rates would be maintained for a “long time”. This series is looking at some of the alternative ways to generate income open to those of us here in Bodrum. As we stated in the last Bulletin, if you want to keep funds in GBP, then UK saving accounts currently offer little or no interest. Far more attractive is the UK stock market that has been recovering strongly from the recession but is this too risky for those not used to stock trading? Even taking a cautious approach, returns from stocks should at least be better than UK bank deposit interest and could be considerably better. Some, but not all, stocks also pay dividends which provide income in addition to the change in stock value.
“We must plan for the future because people who stay in the present will remain in the past” - Abraham Lincoln
You do not need to be a maths genius to trade as all sorts of tools are available nowadays to do the calculating for you and all trading web sites provide graphs and figures of share price movements as well as news services. However, it is essential to understand the costs and implications of what you are doing. Of course prices of stocks can go both up and down but, other than at the start of a major recession (as in 2008), many stocks in major companies are a good long term investment. The FTSE 100 has seen major gains in 2009 but still has some way to go before it reaches levels last seen at the end of 2007.
So, if you have never traded stocks before, how do you get started? Well, by far the best way is with a Fantasy Portfolio. Zero risk and zero cost. Most internet trading sites offer you this option – you can buy and sell stocks just as though you were using actual money, try out different strategies and only move onto real trading when you feel comfortable. It also gives you the opportunity of trying out a number of different online trading sites before opening a real account. Alternatively, treat your fantasy portfolio as a hobby and continue to do it for just for fun!
Although trading costs are similar (£10 to £12.50 per trade plus 0.5% stamp duty on purchase), trading sites do vary considerably in other respects. You need to consider ease of use, the amount of free information provided and how up date prices are. Most free online trading sites offer trading prices with a minimum 15 minute delay. If you are a long term investor then that is no problem, but if you intend to day or swing trade it’s not going to be good enough. Day traders buy and sell stocks the same day but to do that you must be prepared to spend most of your working day in front of your PC. Swing traders hold stocks for a few days or weeks to take advantage of short term ups and downs in the price of a particular stock.
A day trader needs a “Level 2” system (which costs) that provides real time pricing and far more information on the market. There are a small number of online trading sites that are still free but provide “streaming” prices i.e. real time prices. You really need one of these if you are going to swing trade. The price of single stock can vary by as much as 5-10% within a single day, even though its closing price may be little changed from its opening price.
The other major consideration is whether you will only trade UK stocks or want access to other world stock markets. Some UK based online trading systems only give you access to UK stocks. Unless you are particularly knowledgeable about another country, it is much safer to start with UK stocks only. Any profits you make on trading are normally subject to Capital Gains tax (assuming you are taxed on UK income) but your Capital Gains tax allowance may well eliminate any tax liability. You may also have the option of holding stocks within your ISA allowance for tax free gains.
“The trouble with the rat race is that even if you win it, you’re still a rat” - Lily Tomlin
So how do you trade online? The first thing you have to do is open a trading account. This will involve the usual money laundering identity checks but the requirements do vary so if you are short on address proving documents, it is worth looking at a number of web sites. Some insist on being sent original documents, whereas others accept faxed or emailed copies. You normally transfer funds into and out of a designated bank account by BACS. The UK stock market is open 08.00 to 16.30 (GMT) so in Bodrum you can trade 10.00 to 18.30 Monday to Friday from your PC (or any other location in the world).
We’ll look at selecting stocks in the next article but, as an example, let’s assume you want to buy £1000 of “Acompany” stock. Your trading screen will show you the latest “bid” and “ask” prices for the stock. The “Ask” price is the buy price for the stock i.e. what you have to pay for one share in Acompany. The “Bid” price is what can sell one share in Acompany for. The sell price will always be less than the buy price, but the difference (“spread”) will vary according to the popularity of the stock, the time of day and the volatility of that stock.
When you decide to buy, you enter £1000 on the dealing screen and will get a real time quote for your deal. Then you typically have 15 seconds to accept or reject that quote. If you don’t accept it, then you need to get another quote. If you accepted the quote, say £10 per share, then the screen will show that you are now the proud owner of 98 shares of Acompany (as it cost you £12.50 to trade plus £4.90 stamp duty) at a total cost to you of £997.40. Selling a stock is a similar process but without the stamp duty. In order to make a profit on this stock, you would need to sell for more than £10.30 per share to cover all your dealing costs.
Although the dealing costs are low, the smaller the value of each trade you make, the higher percentage the dealing costs become. So in our example above, we had dealing costs of £12.50 + £12.50 + £4.90 = £29.90 or 3% of the trade. If we had only purchased half the number of shares, our dealing costs would still have been £12.50 + £12.50 + £2.45 = £27.45 or 5.5% of the trade. So the selling price would have had to be at least £10.55 to make a profit. As a general guide, trading in multiples of less than a £1000 is just not viable unless you are making a long term investment.
In the next article, we’ll look at selecting stocks, what makes the value of stocks go up and down and how to avoid some of the most common mistakes in on-line trading.
Steve Bishop (retired accountant)
stevebrcs@yahoo.co.uk