How to Start Investing in Stocks: A Practical Guide
How to start investing in stocks? Simple. Master a few basic financial concepts, conduct an analysis of your investment target, choose a broker, set your goals and strategies, and start trading!
Each step requires some effort and involvement on your behalf, but the results can be very satisfying if you combine knowledge pertaining to market trends, company performance, and investment techniques.
In addition, the level of technical sophistication required in order to invest in stocks is often exaggerated. Mastery of some fundamental concepts is sufficient for starting a basic investment, which will allow you to learn and grow as you go along.
We will take a look at how to start investing in stocks one step at a time, from key definitions to specific types of orders.
How to Start Investing in Stocks – Key Definitions
I. Financial Instruments
Stocks are financial instruments which grant their possessor an ownership share in a company. They are also called equities (because you purchase a share in a company) or securities (because you secure a share in a company). Thus, legally speaking, you will become a shareholder and will own a part of the said company. The size of your ownership is equivalent to the percentage of shares you own, from the total number of shares released by the company. In addition, some shareholders also have the right to vote on management issues at the annual shareholder’s meeting.
Penny Stocks represent small-value equities in companies which may potentially become very successful on the market later on. While a winning investment can yield head-spinning results, this is a very rare occurrence. By contrasts, investing in penny stocks often leads to disappointment and this “Wild West” of investment is fertile ground for scammers and tricksters. Beginners should steer clear from this area until they gain significant experience.
Bonds are loans which you hand out to a company, or the government, without sharing any ownership. In practice, whenever an entity needs liquidity, it issues bonds which you can buy. When the bonds reach maturity, the entity (private or public) must reimburse you the value of the bond, plus interest. While bonds are generally considered to be a more secure investment, stocks are widely recognized as being able to yield much higher returns. So, if you are a beginner in the world of investment and you have limited funds, stocks are probably what you’re looking for.
II. Key Concepts
Diversified Investment. Always remember that investing all your assets in a single financial instrument, or in a single company’s shares, can be very risky. If the company’s shares plummet, your entire fortune will go down the drain. To prevent this, spread your investment by buying both stocks and bonds in more companies, especially if you want to start investing in stocks with little money.
The Stock Market is an online, or physical location where people trade financial instruments, including stocks and bonds. As such, you don’t start investing in the stock market, but in the stock itself, which you can freely trade to make a profit.
Stock Brokers are specialized professionals who connect buyers and sellers on the stock market. In addition to connecting supply and demand, stock brokers also make a recommendation on what to buy (or sell) and assist in managing investment portfolios. Fees vary in accordance with the stockbroker’s reputation and service package.
How to Start Investing in Stocks – 2 Ways to Make Money
Stock investment is the action by which you purchase stock in a certain company, with the intent of increasing your revenue. There are two ways in which you can make money with stocks: through trading and by cashing in dividends.
I. Trading is the most common way you can make money by investing in stock. The value of stock on the stock market varies in accordance to investor perception as to that company’s performance and potential on the market. So, the idea is to figure out which company’s stock will likely increase in value in the future, buy stock in the said company and then sell it when its market value has increased. Successfully doing this requires considerable market knowledge, a good understanding of business processes and not a small degree of intuition.
II. Dividends consist of regular payments awarded to shareholders by the issuing company, as a means of allowing the shareholder to benefit from the profit which the company is making. Dividends are usually much smaller than the value the actual shares.
Types of Stock
There are two main types of stock: common stock and preferred stock.
Preferred Stock is considered a safer investment because its price is more stable than that of common stock. In addition, preferred stock owners also have priority when it comes to profit redistribution (dividends). In some instances, the company’s board can choose to freeze the payment of dividends if the company is not doing well and profits are low. This category of stock owners is the last to stop receiving dividends. However, if you have preferred stock you will be unable to vote at the annual shareholder’s meeting, thus making it a poor choice for those interested in contributing to the company’s decision-making process.
Common Stock, as the name indicates, is the most common type of stock freely traded on the market. It allows you to participate and vote at the annual shareholder’s meeting. Common stock usually yields higher returns when traded. However, the payment of dividends is conditioned by the company’s policy on profit distribution. As such, if the company is not doing very well, there is a chance dividend payment will stop. Nevertheless, common stock remains the most popular type of stock traded on the market.
Questions You Need to Ask Before Buying Stock
If you’re wondering about how to start investing in stocks, you must first identify your investment target(s) – one or more companies. In our case, we are looking to buy stock which has a high chance of price appreciation in the future. So what do we need to ask ourselves at this stage?
1. Am I familiarized with the company’s line of work?
A firm “Yes” for this one is absolutely vital. If you don’t understand the specificities of the company, you will be unable to correctly assess the reasons behind the company’s performance level on the market, and consequently, you won’t know when to buy/sell stock accordingly.
2. Is the company doing well?
Another key factor which you should always be aware of. When companies underperform, investor confidence naturally decreases and generates a slump in stock prices. However, what you should also keep in mind is that the perception of the company’s performance is what actually triggers investor behavior. For instance, an underperforming company with a history of top performance in the past will still have its shares traded at considerable prices for a time, due to sheer reputation. Other companies could be performing very well after a more difficult period, but will need time to earn investor trust.
3. Have I thoroughly researched the company’s history and earnings?
Knowing how the company performed in the past is the best way to predict stock prices. Even if, per se, this might not be relevant for companies who are capable of significant performance boosts, remember that market perception is the real deal here.
4. Have I checked the company’s share prices and their evolution? Have I correlated them with current macroeconomic conditions and outlooks?
Determining future stock prices is never an exact science, but much can be done to eliminate uncertainty in this regard. As such, looking at the history and earnings of the company in question is not enough. You should also correlate stock price fluctuations with past macroeconomic conditions and events, so as to determine which of these have had a larger impact on company performance. By extending the principle, you will be able to predict stock prices by keeping a close eye on relevant factors such as economic growth, sector demand, international trade deals, tariffs and monetary & fiscal policy.
5. Have I researched the company’s competitors?
The structure of the relevant market is extremely important when thinking about how to start investing in stocks. Precisely determine how your target company is located on the market: is it an underdog, a market leader or has established itself on a niche?
How to Start Investing in Stocks – Know your Business and Know the Market
In light of what has already been said, there are two main complementary techniques of determining what will influence stock prices, and thus group the main questions listed above – fundamental analysis and technical analysis. For a long time, many investors have considered the two to be at odds with each other. However, as we shall see, using both at the same time will give you a much better chance to accurately predict what will happen to stock prices.
1. Fundamental analysis
Fundamental analysis means studying company performance from the inside out in order to determine how it will perform in the future. This means looking at income, profit, cash flows, balance sheets and other financial statements. Correctly interpreting corporate documentation requires some knowledge in the fields of accounting and business administration. Alternately, a broker or financial consultant can provide specialized assistance in this regard.
2. Technical Analysis
Technical analysis refers to looking primarily at overall market conditions in order to predict stock prices. This means studying product prices and product success, overall demand, marketing campaigns and public response to similar goods and services offered by competitors.
The best (and most difficult way) is to carry out both types of analyses, in order to better understand how both firm and market work, in your area of interest.
How to Buy Stock – The Basic Steps
Now that you’ve become familiarized with some fundamental concepts related to trading stock, let’s talk about the actual steps you need to take in order to actually trade. While “trading” is widely used as a generic term for the entire process, the actual transaction is “executed”. So, let’s take a look at what you have to do in order to execute a stock transaction.
I. How to Choose a Broker and Open a Brokerage Account
The first thing you will want to do when considering how to start investing in stocks is to open a brokerage account at a specialized firm. The brokerage firm, as previously mentioned, is the hub where demand and supply on the stock market meet, with broker being able to assist with all operations related to trading.
In order to open a brokerage account, most firms require you to be at least 18 years of age and to have a minimum account balance of anywhere between $500 and $1000, depending on the firm. The brokerage account can be opened online or directly at the brokerage firm’s location.
In order to avoid scams and any other type of financial unpleasantness, make sure that:
Your brokerage firm (or broker) is reputable and reasonably well-known;
Your broker actually knows his trade;
You can get face-to-face assistance from the broker;
You are informed as to the conditions in which you can add and withdraw money from your account. Some firms are restrictive in this regard;
You are informed regarding the specific fees for each type of transaction. Most firms charge an amount directly proportional to the level of direct assistance that the broker provides;
How to Start Investing in Stocks? Simply contact your broker in order to get started with your first transaction. The first thing you will want to do is buy stock. As such, there are five types of basic orders which you should know about:
1. Market Order
The standard type of transaction. Allows you to buy or sell stock at the present market price.
2. Limit Order
If you only want to buy/sell stock at a specific price, you can opt for a limit order. This type of order only executes the transaction when the stock’s price reaches a value, or an interval, of your choosing. If the price doesn’t reach the said values, the transaction will not execute.
3. Stop Order
A stop order is a type of market order which automatically executes when stock prices reach a preset level. This allows investors to curb losses early on before stock prices fall too low (when selling), or to gain more benefits, before stock becomes too expensive (when buying).
4. Stop-Limit Order
A combination of the previous two types, the stop-limit order allows you to set a price interval when the transaction will execute. However, the transaction will also execute if the prices rise or fall too much, which allows you to simultaneously hunt for opportunities and dodge price twists.
5. Trailing Stop Order
A trailing stop order is similar to the stop order, with the notable difference that the transaction executes when stock price percentages, rather than absolute values, change. Useful for portfolios with stock from numerous companies.
While the simpler orders are what you would probably consider starting with, consult your broker in order to determine which one is best for your particular needs. Also, remember that once an order is placed, there is no turning back. Thus, carefully consider all the factors before making a transaction.
Check out more information about stock orders in this great tutorial:
Conclusions on How to Start Investing in Stocks
If you have some minimal financial resources, business spirit and a willingness to learn something new, you will quickly find out everything about how to start investing in stocks. The steps are the same as in any other business venture: research, plan, choose a target and act! It’s really up to you and how quickly you can master some key skills. If you have a general interest in investment, you’ll also be interested in this guide.