Online trading definition – What is online trading?
Online trading refers to buying and selling securities using an internet-based trading platform. A wide variety of instruments, including stocks, forex, commodities and cryptocurrencies, can be traded online.
Online trading platforms can be desktop based, browser based or take the form of mobile apps. In most cases, trades are routed via a broker.
How does online trading work?
To trade on any financial market, you will need some form of access to the market. Access to a market means you can view live prices and submit orders. In the case of some markets, like stock markets, a broker must submit your order to the stock exchange. In the case of forex markets, your order is submitted to the interbank currency market by a broker.
Before the internet was around, the only way to trade was by phoning a stockbroker or visiting their office. Either way, this was a slow process, and once an order was placed, the broker had to then phone their representative at the exchange, and then relay the message to a trader on the floor. This method of trading was also expensive due to the number of people a broker needed to employ. Online trading means that anyone with an internet connection can cheaply submit and execute a trade in seconds. But that’s not the only advantage of online trading.
Technology has led to the evolution of new types of trading instruments that are ideally suited to individual traders. It has also led to professional trading and analysis tools being made available to individual traders.
Online brokers provide their clients with online trading platforms that can be installed on a PC or mobile device, or are accessible via a web browser. These platforms allow clients to view live market prices and submit their orders.
Types of assets you can trade online
Stocks are shares in publicly listed companies that are traded on stock exchanges. Globally, there are now more than 20,000 listed companies from every industry in the economy. Short term traders buy and sell stocks to take advantage of prices changes that result from supply and demand imbalances. Long term investors buy stocks to participate in the increasing economic value of a company and to receive dividends.
Cryptocurrencies are digital currencies that exist on a distributed ledger or blockchain. This is the newest asset class, having only emerged since 2009. Cryptocurrencies can serve as a medium of exchange (MOE), store of value (SOV) or as a token to power a decentralised platform. Cryptocurrencies are very volatile and need to be approached with caution.
Currencies, or forex, form the largest asset class in terms of the value traded each day. While traders speculate on the changing values of currencies, the largest traders are importers and exporters, and global investment funds. Currency prices are affected by economic factors including interest rates, inflation and growth, and by political relationships too. Having an interest in world events and economics is an advantage for currency traders.
Metals are one of three one of three types of commodities. Precious metals like silver and gold are traded by speculators and held by investors as a store of value, in addition to a hedge against inflation. Industrial metals like platinum, copper and iron ore are widely used in manufacturing and construction. The prices of these metals are closely related to global economic activity.
Agricultural products, or soft commodities, are the second type of commodity. Commodities include livestock like cattle, crops like corn and wheat, and materials like timber. The prices of soft commodities are affected by weather and changes in consumer demand.
Oil and Gas
Energy products like oil and gas are another type of commodity. Other energy products like heating oil and coal are also traded, though most traders stick to crude oil and natural gas because the markets have higher trading volumes. Oil and gas prices are dependent on industrial activity, production and geo-political issues.
Indices are indicators that indicate the performance of a collection of assets. They can include all the largest stocks in one market, the stocks within a sector, or any other type of assets. Indices are used to give investors an indication of how the average instrument within an asset class, market or sector, has performed over a given time period. Because an index is just a list of securities, it cannot be traded directly.
An ETF, or exchange traded fund, is a basket of securities that is listed on an exchange like a share. Most ETFs replicate an index made up of stocks, bonds, commodities or any other asset. ETFs allow traders and investors to gain exposure to an index or a specific sector of a market with just one instrument.
Types of Instruments
In many cases, trading assets directly is not practical, or is very expensive. However, there are several types of trading instruments that allow a trader to participate in the price movements of an asset in a cheap and easy way.
Contracts for Difference, CFDs, are a type of derivative trading instrument. A CFD is a contract between a trader and broker that allows the trader to earn the difference between the price of an asset when they buy and sell the contract.
CFDs allow traders to participate in the price movement of an asset without actually buying the asset. They are the easiest way for traders to trade a wide range of asset classes including stock, currencies, commodities, indices, ETFs and cryptocurrencies. CFD traders can increase their exposure by using leverage with a CFD.
A trader believes the price of Apple will increase. They buy CFDs on 10 Apple shares at a price of $204.50. The leverage is 5 to1, the commission is 0.2%. The total value of the trade is $2045.00, so the 5 to 1 leverage implies a margin of only $409 is needed for the trade. The $4.09 commission is subtracted from the trader’s account.
Apple’s share price rises by $10 and the trader closes the trade at $214.50. The trader’s margin is returned to their trading account and a commission of $4.11 is deducted from the account. The trader’s profit is $200, minus the $8.20 paid in commission, so $191.80.
A binary option is an instrument which expires with either 100% or 0% of its value, based on the outcome of an event. Binary options can be based on any event with ‘yes or no’ outcomes.
Binary options usually have an expiry date and an outcome which will or won’t be realised. The outcome can be based on an asset price being above or below the price at the time of entry, or on the price reaching a defined level by a certain time and date. Binary options expire at $100 if they are in the money, or $0 if they are out of the money. The price of a binary option will vary between $0 and $100 as the expiry date approaches.
A trader buys a binary option based on whether Apple’s share price will be higher than $205 at midday on the last day of the month. At the time, Apple’s share price is at $204 and the option is trading at $55.
At midday on the last day of the month Apple’s share price is at $202. The option therefore expires worthless and the trader loses the $55. If the share price had been higher than $205 the options would have expired at $100, netting the trader $45.
Futures contracts are derivative instruments that trade on futures
exchanges and have standardized contract specifications. A futures contract is an agreement between two parties to buy or sell an asset at a fixed price on a specific future date.
Futures contracts are similar to CFDs, but are traded on exchanges. Contract size, index multiplier, margin and expiry date are also standardized. The minimum trade value for futures contract is much larger than for CFDs.
A trader buys one S&P 500 futures contract at a price of 2,990. The index multiplier for S&P futures contracts is $250, so one contract is worth 2,990 x $250 or $747,500. The margin required is $33,500 per contract. The trader closes the position at 2,995, netting a profit of 5 x $250, or $1,250, minus commissions that cost around $4.
Pros and Cons of these types of instruments
Online Trading Methods
There are lots of different approaches to online trading. Traders and investors can combine some of the following methods and time frames to develop their own strategy.
- Day traders open and close positions within the same day. Most day traders focus on technical analysis and use charts with time frames ranging from 5 minutes to 4 hours. Day traders need to be able to follow the market continuously all day.
- Swing traders hold positions for periods of 2 to 5 days. These trades take advantage of the way prices oscillate within a trend or trading range. Swing traders use charts, as well as news events and fundamental analysis, to guide their trading.
- Investors hold positions for at least 6 months and usually much longer. Investors focus on the fundamentals that contribute to the profits a company generates. These include products, leadership, market size and profitability.
- Technical traders use chart patterns and indicators to find opportunities, time their trades and manage risk. Technical trading can be used on any time frame, from minutes to weeks or months.
- Trend followers use a systematic approach to capture long term trends that range from months to years. Trend following requires nerves of steel to ride through periods of volatility.
- Mean reversion traders exploit the tendency of prices to mean reversion. They use chart patterns and technical indicators to find opportunities when an instrument is trading at extreme levels.
- Fundamental factors like company size, growth, value or dividend yield are used by investors to pick stocks they expect to perform well over time.
Pros and Cons of Online Trading:
- Financial independence: Successful online traders can become financially independent. That means being financially secure without the need for a job, a boss or clients, in addition to being able to live where one wants.
- Access global markets: Online trading allows anyone to access any market in the world. This includes numerous stock markets, forex, commodities and cryptocurrencies.
- Lower fees: Online trading platforms offer lower fees than traditional brokers, financial advisors or investment management products.
- Flexible schedule: Regardless of your schedule, you will be able to find a market and time frame to trade.
- Trade from anywhere: Provided that you have an internet connection, you can trade from anywhere in the world.
- Back testing: Online trading platforms can be used to back test a strategy to see if it is profitable before trading it live.
- Steep learning curve: It does take time to learn to trade successfully, and the learning curve is steep.
- Risk: Any type of trading is risky and real money can be lost. Risk management is therefore of paramount importance.
- Stress: Online trading can be stressful when things go wrong. Traders need to learn to manage their stress levels and maintain a healthy lifestyle.
- Requires capital: Although it’s easy to start online trading, capital is required to begin trading.
Online trading can be incredibly rewarding, both as a full-time occupation or as a way to earn a second income. However, there are challenges and it needs to be taken seriously, and not treated as a hobby.
Can anyone become a successful online trader?
Almost anyone can become successful at trading if they find a method and approach that suits their personality, and provided they put in the time to learn. Different trading styles suit different personalities and it’s crucial to find a time frame and style that work for you.
Starting out small and learning to manage risk are also important to maintaining your confidence as a trader.
How to start
Step 1. Choose your trading style and market
Your first step is to choose an approach to trading that you think will suit your personality, and more importantly, your schedule. If you have a full-time job, you won’t be able to be a day trader. If you are able to check in on the markets a few times day, you’ll be able to swing trade. If not, you can trade using daily or weekly charts by doing your analysis and placing an order in the evening or over the weekend.
You will also need to decide which markets to trade. Forex is best for people interested in economics and big picture themes. Stocks are ideal if you are interested in businesses and consumer trends. Stock will also require more time to research, as there are so many of them.
When you start out, keep things simple and focus on learning and following a process, rather than on how much money you make or lose. It may take a bit of experimenting to find a trading style that suits you. With a bit of perseverance, you should get there eventually, and you’ll learn a lot about yourself in the process.
Step 2. Learn and do your research
Traders never stop learning, and the sooner you begin, the sooner you will be able to become consistently profitable. There are lots of free resources on the web, and many great trading books. Regardless of your trading method, you should learn a little about fundamental and technical analysis. You should also pay particular attention to learning about trading psychology. In addition, keeping up to date with the news from your chosen markets will get you up to speed with what moves prices.
You will also need to get to know the trading platform you are using. Platforms like MetaTrader offer lots of video tutorials, so it really shouldn’t take a long time to get familiar with your trading platform.
Step 3. Create an online trading plan
Successfully traders follow a deliberate process and plan when trading. This starts with setting time aside to analyse markets, and a clearly defined process for identifying opportunities, entering, managing and exiting trades. Every trade should have clearly defined entry criteria, profit targets and an exit strategy. All trades should be recorded in a journal and reviewed afterwards.
Step 4. Set up a risk management plan
Trading is as much about managing risk as anything else. You should always be aware of how much you are risking on a trade and how much of your portfolio is at risk at any given time. You should also know the maximum amount you are prepared to lose on a single trade and during a single day, week and month. Profits and losses often come in streaks, and it is essential to limit the damage that can be done by a losing streak.
Step 5. Take your first trading steps with your demo account
Paper trading means following an entire trading process without putting real money on the line. This can be done with a paper journal or an Excel sheet. However, it is far easier to open a demo account using a proper platform like MetaTrader. This will allow you to develop a trading process using the exact same tools you will use with real money on the line.
Whether you want to trade online full time, or as a side project, it can be a very rewarding and lucrative adventure. If you want to get started, you can open a free demo account with Libertex.
Libertex is a broker and trading platform which offers CFDs stocks commodities, indices, ETFs and cryptocurrencies with leverage of up to 30. The platform offers free trading tutorials and state of the art trading tools.
The points mentioned in this article will help you get started, but ultimately, to make progress, you will need to take the plunge by creating a trading plan and getting your demo account up and running.
Why trade with Libertex?
Access to a demo account free of charge
Technical assistance to the operator 5 days a week, 24 hours a day
Leverage up to 1:500 for Professional clients
The use of a platform on any device: Libertex and Metatrader 4