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Stock Trading

Most stocks are traded (bought and sold) on exchanges, such as the New York Stock Exchange and the Nasdaq, where traders get together and decide on a price. Some exchanges are physical locations, where buyers and sellers make their transactions on a trading floor; others are virtual locations, consisting of a network of computers.

Individual investors can access the markets and trade stocks through a broker using different methods:

A market order is the most straightforward method of placing a trade. A market order tells the broker to buy or sell at the best price he or she can get in the market, and the trades are usually executed immediately. Since Morningstar recommends a long-term investing philosophy, fretting over a few pennies here and there doesn't make sense to us, and a market order is best in most cases.

A limit order means you can set the maximum price you are willing to pay for a stock, or a minimum price you'd be willing to sell a stock for. If the stock is trading anywhere below your maximum purchase price, or above the minimum selling price, the trade will be executed. However, because there are limitations when a limit order is placed, the trade might not be executed immediately. Also, some brokers charge extra when a limit order is requested.

Trading Vs. Investing

At Morningstar, we believe solid stock investing is not about trading, having the fastest computers, or getting the most up-to-the-second information. Though some professionals make their living by creating a liquid market for stocks, actively "day trading" is simply not how most good investing is done by individuals.

Beyond having to expend an incredible amount of effort to track stocks on an hour-by-hour basis, active day traders have three powerful factors working against them. First, trading commissions can rack up quickly, dramatically eroding returns. Second, there are other trading costs in terms of the bid/ask spread, or the small spread between what buyers are bidding and sellers are asking at any moment. These more hidden frictional costs are typically only a small fraction of the stock price, but they can add up to big bucks if incurred often enough. Finally, frequent traders tend not to be tax efficient, and paying more taxes can greatly diminish returns.

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