Investing in stocks is an excellent way to grow wealth. But how do you actually start? Follow the steps below to learn how to invest in stocks and the best strategy to make money investing in stocks.
- What is stock
- How to invest in stocks
- How to make money in stocks
- CASE STUDY
What Is Stock?
A stock is an investment. When you purchase a company’s stock, you’re purchasing a small piece of that company, called a share.
Investors purchase stocks in companies they think will go up in value. If that happens, the company’s stock increases in value as well. The stock can then be sold for a profit.
A Stock is a security that represents an ownership share in a company. For companies, issuing stock is a way to raise money to grow and invest in their business. For investors, stocks are a way to grow their money and outpace inflation over time.
When you own stock in a company, you are called a shareholder because you share in the company’s profits.
Public companies sell their stock through a stock market exchange, like the Nasdaq or the New York Stock Exchange. (Here’s more about the basics of the stock market.) Investors can then buy and sell these shares among themselves through stockbrokers. The stock exchanges track the supply and demand of each company’s stock, which directly affects the stock’s price.
Stock prices fluctuate throughout the day, but investors who own stock hope that over time, the stock will increase in value. Not every company or stock does so, however: Companies can lose value or go out of business completely. When that happens, stock investors may lose all or part of their investment. That’s why it’s important for investors to spread their money around, buying stock in many different companies rather than focusing on just one.
» Ready to learn more? Install the stock market simulator for mobile, desktop or browser and notice what a stock is and how to invest in stocks in real-time with virtual funds.
How to invest in stocks?
Step 1 - Decide how you want to invest in stocks
There are several ways to approach stock investing. Choose the option below that best represents how you want to invest in stocks, and how hands-on you'd like to be in picking and choosing the stocks you invest in.
- "I'm the DIY type and am interested in choosing stocks and stock funds for myself." Keep reading; this article breaks down things hands-on investors need to know. Or, if you already know the stock-buying game and just need a brokerage, see our roundup of the best brokerage accounts.
- "I know stocks can be a great investment, but I'd like someone to manage the process for me." You may be a good candidate for money management, a service that brings managers and investors together, allowing investors to earn on the Stock market without trading on their own and managers to receive additional income through efficiently managing investor funds. Virtually all trades made by the manager are reflected proportionally in the investors' accounts. See our top pick for money managing service.
Once you have a preference in mind, you're ready to shop for an account, which we cover next.
Step 2 - Open a stock investing account
Generally speaking, to invest in stocks, you need an investment account. For the hands-on types, this usually means a brokerage account. For those who would like a little help, opening a managed account or social account is a sensible option. We break down both processes below.
An important point: Both types allow you to open an account with very little money, starting from 1.000 USD or equivalent in local currencies.
THE DIY OPTION: OPENING AN INDIVIDUAL BROKERAGE ACCOUNT
An online brokerage account likely offers your quickest and least expensive path to buying stocks, funds and a variety of other investments. With a broker, you can open an individual account that offers access to the largest stock exchanges in the world and different asset classes, from individual stocks to stock indexes and exchange-traded-funds, but also commodities, currencies, and cryptocurrencies.
THE PASSIVE OPTION: OPENING A MANAGED/SOCIAL ACCOUNT
A managed or social account offers the benefits of stock investing but doesn't require its owner to do the legwork required to pick individual investments. The money managing service provides complete investment management offering unique features like:
- The manager needs to invest his own money into PAMM/Social Account.
- The manager can not access the investor's funds.
- The predefined performance fees that are earned by the account manager are automatically withdrawn from investors’ accounts. Profit or loss are divided among investors/followers on a proportional basis.
This may sound expensive, but the management fees here are generally very low.
Step 3 - Know the difference between stocks and stock mutual funds
Going the DIY route? Don't worry. Stock investing doesn't have to be complicated. For most people, stock market investing means choosing among these two investment types:
- Stock mutual funds or exchange-traded funds. These mutual funds let you purchase small pieces of many different stocks in a single transaction. Index funds and ETFs are a kind of mutual fund that tracks an index; for example, an S&P 500 fund replicates that index by buying the stock of the companies in it. When you invest in a fund, you also own small pieces of each of those companies. If you want mutual funds and have a small budget, an exchange-traded fund may be your best bet. Mutual funds can have minimums of $1,000 or more, but ETFs trade like a stock, which means you purchase them for a share price — in some cases, less than $100.
- Individual stocks. If you’re after a specific company, you can buy a single share or a few shares as a way to dip your toe into the stock-trading waters. Building a diversified portfolio out of many individual stocks is possible, but it takes a significant investment. The amount of money you need to buy an individual stock depends on how expensive the shares are. (Share prices can range from just a few dollars to a few thousand dollars.)
The upside of stock mutual funds is that they are inherently diversified, which lessens your risk. But they're unlikely to rise in meteoric fashion as some individual stocks might. The upside of individual stocks is that a wise pick can pay off handsomely, but the odds that any individual stock will make you rich are exceedingly slim.
For the vast majority of investors — particularly those who are investing their retirement savings — a portfolio comprised mostly of mutual funds is a clear choice.
Step 4 - Start investing in stocks
Stock investing is filled with intricate strategies and approaches, yet some of the most successful investors have done little more than stick with the basics. That generally means using funds for the bulk of your portfolio — Warren Buffett has famously said a low-cost S&P 500 index fund is the best investment most Americans can make — and choosing individual stocks only if you believe in the company's potential for long-term growth.
If individual stocks appeal to you, learning to research stocks is worth your time.
Here is a quick summary of what to look for in an investment stock, keeping in mind the two points discussed above. Use a stock screener to find stocks that fit the following criteria.
- Dividend yield over 5%, but the payout ratio below 100%.
- Average volume over 300,000 shares.
- Priced over $2; no penny stocks.
- IPO date more than a year ago; preference is given to stocks which have been publicly traded for 10 years or more.
- P/E greater than zero (shows the company is profitable). Consider looking for stocks with a low P/E, for example, greater than zero but less than five. Also, consider looking at stocks where the Forward P/E is lower than the current P/E. This shows earnings are expected to increase, and if they do the stock is a better buy at the current price.
- Operating Margin Over 10%.
Screening for stocks based on the filters above will produce a list of possible trade candidates. All are not worthy of investment though.
View charts of the stocks produced by the screener above. The next criteria for investing in a stock is:
- Only buy stocks at the major long-term support area. We want to buy stocks at relatively cheap prices (compared to historical values), not expensive prices. Investment trades don't require a stop loss, but you should have a price in mind where you get out if conditions don't improve for the stock. An investment doesn't mean you hold it forever if it doesn't do what you expect. Have a low tolerance for stocks that keep dropping.
Also, have an exit plan for how you will exit a profitable trade. Define how and why you will exit. Since we used support to get into the trade, you may consider exiting just below a long-term resistance level. Once you are out of your trade, don't worry about what the stock does after. Take the money and invest in other stocks, going through the same process again, as discussed above.
This brings us to one final guideline on how to invest in stocks:
- If buying at support, and planning to exit just below resistance, the upside potential should outweigh the downside risk (to $0) by at least 2:1. That means that if you buy at $5, you should be reasonable able to get out of the stock at $15 or higher. In an absolute worst case you lose $5 a share (but since we don't hold losers forever, this is highly unlikely), but based on the historical chart it is quite feasible to make $10/share or more. This is known as the risk/reward ratio.
How to make money in stocks?
Stock investments carry more risk than some other investments, but also have the potential to reap higher rewards. Stock investors earn money in three main ways:
- If the price of a stock goes up during the time they own it, and they sell it for more than they paid for it.
- Through dividends. Dividends are regular payments to shareholders. Not all stocks pay dividends, but those that do typically do so on a quarterly basis.
- If the price of the underlying currency goes up during the time they own it, and they convert the funds back after selling it.
Over the last century, the stock market has posted an average annual return of 10%. The word “average” is important here: Not only is that return an average for the market as a whole — rather than a specific individual stock — but in any given year, the market’s return can be lower or higher than 10%.
You can buy individual stocks through an online broker. The process of opening a brokerage account is similar to opening a bank account. The commissions charged by online brokers for stock trades vary, so it’s important to shop around. With AM Broker the commission is as low as $1 per transaction.
Today, much of the advice that purports to cover investing in the stock market focuses on individual foreign or local stock picking without regard to a critical aspect - the quality of the underlying currency.
That brings some diversiﬁcation but still fails to consider whether or not you’re diversifying into a currency that’s any better than what you’ve already got. The purpose of diversifying into other currencies is to get into the stock market game with the best chances for long term appreciation.
A good investment in a bad currency can become a bad investment and vice versa.
For example, consider the case of the polish stock market investor. Even if your portfolio has done well in Polish currency (PLN) terms, over the past years, the picture is less rosy against other major currencies and commodities, like USD or USD denominated commodities. Because we all use imported products, this means your purchasing power and wealth are melting away if your stocks are in a declining currency like the PLN. For example, anyone whose stocks are too concentrated in PLN has paid the penalty countless times whether they realize it or not.
To protect yourself, you need as much of your stocks as possible to be denominated in the currencies that are likely to hold their real value or appreciate in the long run and lift your portfolio along with them. Because a good stock market investment denominated into a wrong currency may become a bad stock market investment and vice-versa.
Investing in the Stock market in your country short version: ﬁrst you identify the currencies you want represented in your portfolio, then you allocate a percentage of your portfolio to each one, and ﬁnally, you choose the individual stocks (shares or stock indices) that provide that given percentage exposure. That’s the basic idea. Obviously, you’ll need to weigh the quality of the stocks you buy or indices versus that of the currency.
Here’s the more detailed version of the steps involved to start playing the stock market the right way to profit twice.
Step 1 - Identify the right currencies
- Study currency market weekly or monthly charts or representative currency indexes for your projected holding period. If you’re planning to buy and hold stocks for months to years, you want to see trends over the prior few years. For support, read also what is forex and how does it work.
- Identify the currencies with the healthiest uptrends over that period. For support, read how to invest in forex for income.
- Check that the underlying national economic fundamentals support that trend with relatively good growth, or at least consistently low ratios of debt to the gross domestic product (GDP) and culture of ﬁscal discipline, not growing budget and trade deﬁcits. For support, read also how to use the forexfactory.com calendar and how to read the news.
Step 2 - Allocate a percentage of your portfolio to each currency
Allocate percentages of your portfolio for income-generating instruments denominated in or tied to those currencies that are more likely to appreciate in the long run.
Step 3 - Choose the individual shares that provide that given percentage exposure
Then shop around for speciﬁc assets you want that are denominated in or exposed to those currencies so that you have a set portion of your portfolio in both the right currencies and assets in those currencies. The research method is the same as for any shares and bonds buying, forex and commodities, and so on. The only difference is that in addition to your normal screening criteria, you screen by country or currency, either traditional shares listed on a stock exchange or indices and shares CFD (IF you prefer CFD trading, a more flexible alternative to traditional share dealing, but also riskier) that meet your investment criteria.
Case Study - Applying Forex Trends to Invest in Stocks
Imagine that three years ago a Polish investor (No. 1) decided to seek currency diversiﬁcation for his portfolio beyond the Poland Stock Exchange, converted 100,000 PLN to USD, and invested the sum in a basket of US stocks that comprise the DOW JONES index, an index that tracks the American shares listed on the New York Stock Exchange. His friend, fellow Polish investor No. 2, took the same sum and invested it in a basket of Polish shares listed on the Warshaw Stock Exchange that comprise the WIG20 index (WIG components - eg. JWS shares, pro shares, ...).
Note: The following assumes that dividend stock prices of the United States and Poland move in the same direction as the primary national stock indexes just for the sake of comparison, and does not take into account gains from dividends, commissions or any other fees.
Obviously, we have a strong and overall very steady uptrend for the USDPLN course. Here are the numbers*:
- USDPLN, 1 June 2014: 2.99
- USDPLN, 1 June 2017: 3.70 Change: +0.71 Percent change: +23,74%
*(opening price in web.ambroker.com)
During the last 3 years, investor No. 1 gained almost 24% over investor No. 2 just on currency appreciation.
Of course, currency appreciation by itself isn’t necessarily enough. If you don’t have the right investments in a given currency, you still could lose.
Anyway, just looking at relative currency performances, the USD denominated assets looks like the best investment.
Three years ago investor No. 1 converted 100,000 PLN to USD, then invested that in the S&P/DJIA composite index or a similar basket of stocks listed on NYSE:
- 100,000 PLN into USD in mid 2014 became: $33,000
- That $33,000 invested in stocks grew to be about ($33,000∗27% SP500 appreciation): $41.910
- That $41.910 converted into PLN after 3 years ($41.910∗3.7 UsdPln rate): 155,067 PLN
Three years ago investor No. 2 invested 100,000 PLN in the WIG20 composite index or a similar basket of stocks listed on WSE:
- That 100,000 PLN invested in the WIG20 in mid-2014 became about: 96,000 PLN
- Difference 59,000 PLN
In sum, our sample investor No. 1 who went with US currency and bought stocks beneﬁted from both currency and stock market trends for a gain of 55,000 PLN versus a $4,000 loss for No.2, who stuck with PLN currency and stocks.
In sum, how to invest in stocks
The trick to succeeding in the stock market is to ﬁnd nations that have both rising currencies and rising stock exchange. You’d use monthly and weekly charts covering last years, looking at both forex pairs and major global stock market indices.
Being in the right stock investment but in the wrong currency is like swimming against a strong current. No matter how much you think you’re moving ahead, the current keeps pulling you back, impeding your progress or setting you back despite otherwise successful stocks investment choices.
Conversely, being in both the right stock investment and the right currency is like swimming with the current; you progress much faster if your investments swim well, and even if they don’t, they can still get carried forward in value by the current of a rising currency.
In other words, even if your stock investments aren’t the best, if they’re linked to or denominated in the right currency (learn what is forex trading and how to make money with it), your net worth keeps moving in the right direction.
Buy strong dividend-paying stocks on the cheap. Stocks can't go higher forever and beaten-down stocks don't typically stay low forever (unless something is seriously wrong). Use the criteria discussed above to find stocks to invest in.
Unfortunately, there are no guarantees. A stock may look great based on the factors discussed above, but continue to fall in price. The article above discusses tendencies, which apply to many stocks, but any single stock can defy the tendencies. The above list provides a summary of why to invest in stocks and a basic screen for finding some stocks which may be priced at a value. We dig much deeper though before making a trade; for every 30 stocks analyzed using this approach, only one or two may be worth investing in.
This article provides the starting point for your stock investment analysis.
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