How you can instantly lose money in the stock market, and why percentages matter
When I first started investing in the stock market I fancied myself as a bit of a trader. I liked the thought that I could buy low and sell high, and impress my friends with tales of making a quick killing on the latest tech stock. So with images of Gordon Geko from Wall Street running through my head, I started buying shares left, right and centre. But I soon realised I had no clue at all about what I was doing and I would never make any money if I carried on like this!
The fees are how much?!
For a start, I didn’t think about how much stock I should be buying at a time. Surely if I just buy some shares and they go up in value then I’ll instantly make money right? Well no, actually. When you purchase shares from a platform like Hargreaves Lansdown you have to pay a trading fee which varies slightly depending on how many trades you’ve made the previous month but is usually £12.50 if you don’t trade that much. You also have to pay stamp duty on the shares at a rate of 0.5% of the purchase amount.
As if that wasn’t bad enough there’s also the spread to contend with. If you look on the trading page for the shares you’re interested in you’ll see two prices – one is the offer price or the price the money market will sell you the shares for, and the other is the bid price or the price the market will buy them back for. Note that the names ‘bid’ and ‘offer’ are referred to from the market’s perspective, not yours.
The bid price will always be lower than the offer price, so if you were to buy some shares and immediately sell them you would be out-of-pocket even before taking into account the trading fees. Now if you purchase a few shares at a time like I did, then you need the shares to increase in value by a higher percentage than if you bought a lot of shares in one go.
How the bid-offer price affects you
Let’s go ahead and buy £500 of shares of Widget Ltd at £5 per share. You place the order and are asked if you want to confirm, at which point you happily click the proceed button without looking at the trading details, and you’re then presented with a purchase contract. However, to your horror, you notice that your trading screen doesn’t actually say that you own £500 of stock.
What’s actually happened is that you’ve paid £500 for the shares, plus £12.50 for the trading fee, plus £2.50 for stamp duty and have lost £5 from the spread (100 shares with a 5p bid-offer spread). Your £500 of the stock has actually cost you £20, so you’re down by 4% before you’ve even started. If you were to immediately sell your shares you’d have to pay another £12.50 trading fee so you’d be down £32.50 without very much effort at all. To break even your shares would have had to increase by 6.5%!
Now contrast that with buying £5000 of shares. That works out at £5000, plus £12.50 trading fee to buy, plus £25 stamp duty plus £50 for the spread. A grand total of £5087.50. You then immediately sell the shares and grudgingly pay the £12.50 trading fee for a total of £5100, or a loss of £100. But as a percentage, your shares would have only had to increase by 2% to break even.
The moral of the story is it’s easier for your shares to go up in value by 2% than 6.5%, therefore if you can afford it you’re better off buying as many shares in one go as you can afford to. As someone who isn’t exactly dripping in riches I’ve settled on a minimum figure of £2000 per stock, but of course, it’s entirely up to you how much you want to spend.