Stock market investing can be scary if you are just starting out or have no previous knowledge of trading or finance. In this review, I will help get you started trading in the stock market with more confidence. The stock market is not scary and can be an amazing way to build wealth and income. As with everything, it takes time and education to be truly effective.
You may have recently heard in the news that Twitter (TWTR) shares are down or Facebook (FB) shares have fallen. Why does this happen? And will they go back up? Can I buy shares of Twitter or Facebook? Short answer is yes, you can. In the next few paragraphs, I go through some of the basics. This includes; Defining stocks, explaing what accounts you need to trade, how to trade, some common investing strategies and how to do some basic research on companies. Also at the end, I will give you my final take on stock market investing and why it may be a good path for you.
What On Earth Are Stocks?
If you have read any of my post on ‘ETFs’ or ‘Mutual Funds‘, there could be some slight repetition in this post, but understand that stock investing is different than either ETFs or Mutual Funds. A stock, also known as equity in a company is a portion of ownership in that company. This ownership entitles you to a share or portion of the company’s profit. The more stock you own of a company, the more equity you own in the company. Thereby, resulting in more stake in the profit or loss of that company.
Corporations offer stock to investors as a way to get money. A corporation will sell shares of ownership to fund projects, to expand, or to get cash. The two forms of stock are common stock and preferred stock. There are multiple nuances to both, but from a general perspective, the shares of common stock are traded on the stock exchange and usually offer more growth, but less consistent income than a preferred stock. Preferred stocks typically do not have as much growth potential, but get a dividend payment. A dividend is a distribution of some of the earnings to the shareholders. When we discuss stock market investing, common stock is the most widely known.
Stocks will trade on the exchange as letters, called ticker symbols. The example above, Twitter trades under the symbol TWTR, Facebook under the symbol FB. These symbols are the way you can look up the stock information and buy or sell them.
Stock Market Investing: Buying and Selling
The act of buying or selling stocks is actually very easy. We should explore some goals of investing before we jump right in to buying or selling. Typically, the goal is for wealth appreciation or a long-term investing strategy. This is where someone buys stock in a corporation and holds onto it. The concept here is to buy something and watch it grow. If you were to sell the stock at a certain point and the value rose over time, you would receive a capital gain.
Another strategy for stock market investing is an income strategy. This is typically where you buy stocks that have a high dividend and you receive monthly income or quarterly income from the shares of ownership. This is typically not an appreciation strategy. The hope here is that the dividend you receive will offer some consistent income. There are other income strategies that involve trading options, but that is for another post. In any of these strategies, however, the value of the stock could go up or go down. There is no control over your risk of loss or potential for gain. One of the easiest risk management strategies is diversification, which we talked about in ‘Investing in ETFs‘.
A key aspect of stock market investing is, of course, trading. In order to be able to trade stock, you must first have an account. The two most common accounts are brokerage and retirement. There are nuances to each, but in a general sense the main difference is how they are taxed. Typically any gain in a retirement account is not taxed until you withdraw funds. Conversely, any gain in a brokerage account is taxed immediately upon any gain realized. A gain meaning a sale or dividend payment.
Once the account is set up and money is deposited, you are all set to go. When you purchase stock online and go to the trading tab, you should see two prices. One is called the Bid and the other is called the Ask. Whenever you buy a stock, you will pay the Ask price. Likewise, whenever you sell a stock you will receive the Bid price. You will also see order type. This can typically be a Market order or a Limit order. There are others, but these are the main two.
A market order when you are buying stock means that you are willing to take whatever price the current market ask is for that stock. This can be a risky strategy. I would always encourage if you are going to trade stocks, use a limit order type. This basically says, “at that price or better.” So, in our example, if we wanted to buy CocaCola (KO) which last traded at $48.70 and we put a buy limit order in a $48.50, then we would only purchase CocaCola at $48.50 or lower.
Stock Market Investing: Researching Companies
If you are considering stock market investing, one item I would like to bring up is price. Price alone does not determine the value of a company. Many would consider a stock that is trading at a higher price to be a good investment, but that may not be the case. One key factor to consider is the P/E ratio. This is the price to earning ratio and it takes into account the current price of the stock divided into the earnings per share.
Let’s take an easy example. Company A has a price of 10 dollars per share and earnings of $10,000. They have 20,000 shares outstanding in the market. Their earnings per share is .50, so the P/E ratio is 20. (10 dollars per share / Earnings per share) Company B has a price of 50 dollars per share and earnings of $40,000, they also have 20,000 shares outstanding in the market. Their earnings per share is .50 as well, however the P/E ratio is 100. 50 dollars per share / Earnings per share)
In this scenario, Company A is only charging 10 dollars per share and the P/E is 20, so that means that for every 20 dollars you spend you get 1 dollar of earnings versus company B with a P/E of 100, you have to spend 100 dollars to benefit in 1 dollars of earnings. This is of course a very simplistic example, but it makes you think that just because a company trades at a higher price, doesn’t mean it’s always a better investment.
I want to bring up volume because it is important to consider when trading stocks. When I refer to volume, I mean stock trading volume. Volume equals the number of shares traded of a particular company in a given period of time. I think volume is important since it helps you see how liquid the stock is and if people notice changes in the stock and act accordingly. For example, if a stock goes up one day but has really low volume, then goes down the next day on really high volume, maybe the price going up was a fluke. Or maybe they came out with news the day it went down. Volume helps you see if there are particular changes to a company and gives you a reason to research further.
Technical research or technical analysis is a very broad topic when it comes to stock investing. Active traders use this strategy frequently. If you are curious about learning more, I would suggest reading ‘Getting Started in Technical Analysis’. It will give you an excellent starting point and covers many topics on technical analysis. Learn as much as you can with this strategy as there are many options for technical analysis.
Using Ratings for Stocks
In stock market investing, look out for analyst ratings. There are quite a few financial analysts that rate stocks for a living. Similar to my post on mutual funds, we mentioned Morningstar as a mutual fund rating agency, well there are many companies that rate stocks. Typically, any brokerage firm that you open an account with will have the ratings of stocks under the research tab for each company you look for. The ratings for stocks will give you a recommendation, such as buy, hold or sell. Each analyst gives their reasoning behind each recommendation so you are able to see why they give their rating. I would encourage looking at several analysts’ ratings and learn more about each before making a decision purely on their recommendation.
My Take on Stock Market Investing
As you may know by know, I love to suggest books on most of my posts because I think books are key in building your businesses. Plus, financial education is a passion of mine. If you are interested in learning more around investing in general, ‘The Intelligent Investor‘ by Benjamin Graham is, in my opinion the investing bible. There is so much in that book that can help in your investing journey.
I started trading stocks about 15 years ago and enjoy it. There are times when I am more active in my trading and times when I just let things grow. I would strongly encourage that you make investing part of your financial freedom plan. One of the main reasons I would suggest the stock market is because of the liquidity. If you need cash quickly, you are able to sell the investment quickly assuming there is good volume to the stock.
Owning a business or a piece of real estate is great, but getting money out of either can be difficult. Although, business ownership and real estate investing have better tax advantages. So, one is not necessarily better than the other. I would add that owning multiple asset types is the key to success, but stocks can offer easier to access cash. You can learn about the asset classes by checking out this great book, ‘Why The Rich Are Getting Richer’ by Robert Kiyosaki.
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