Learn the Stock Market
There's money in stocks.
To many people, the stock market seems complicated, confusing, and even a little dangerous. It's full of numbers. Everyone seems to have a contradictory explanation for why stocks do one thing one day and the opposite thing the next. Sometimes it seems like you have to have an MBA just to start making sense of things!
Good news! You already know more than you think. If you've ever bought or sold anything, you know the basics of how the stock market works. You're well on your way to learning what you need to know to meet your financial goals. Ready?
What is a Stock?
Suppose you sell cookies. You need to raise money to buy chocolate chips, so your best friend gives you $50. In return, you will pay your friend half of the profit you make. A stock is a piece of ownership in a company. You've sold half of that ownership, so your friend now owns half of the stock of your company.
The stock market is a little bit more formal than that, but the important point is that a stock is a small portion of ownership in a company. That's it. You can explain that to your friends in a sentence.
What is the Stock Market
Suppose your cookie business takes off, and you want to build a factory to handle all of your orders. You need to raise a million dollars (maybe you're buying a factory on sale in the wilds of Canada). Your friends can't afford this, so you offer to sell stocks to the public at large. You talk to a bank and set things up to offer your stock on an exchange. A stock exchange (or stock market) is a place where the public at large can buy and sell shares of your company.
The stock market is a little bit more than this, and the implications of ownership of the company are a little more complicated than this, but the important point is that a stock market is a place where people buy and sell pieces of ownership in companies. This is also known as stock trading, so to learn how stock trading works, you need to know....
How to Buy Stocks
To buy a stock at an exchange you need a broker. A broker handles the hard work of getting buyers and sellers together. A stock market isn't like a grocery store, where shares in Awesome Cookie Company are on the shelf right next to the chocolate chips. It's more like an open-air market full of bartering and bargaining.
Finding a good broker is important, but as is finding a good dentist or a good barber. You want a trustworthy professional who understands your goals and can represent them fairly. Putting your money with a broker. What you really need to do is to learn how to invest in the stock market, and that question is really....
How To Make Money in the Stock Market
Making money in the stock market is like making money in any business: you want to buy something and later sell it for more than you paid for it. That's it. That's the secret of how to make money in the stock market.
A stock is a little more complicated than that: because you own part of a business, you're entitled to share in the profit of that business, if any. You can earn money with dividends too. That's the profit the business may pay out to its owners once, twice, even four times a year.
Why do Stocks Go Up in Value?
Because a stock is a share of a company, the value of a share depends on the value of the company. What's important to a company and its future? How much money the company can earn. That's growth. When you buy a stock, you buy its growth.
It's not like a bond, which is a piece of a loan, where a fixed interest rate tells you how much money you'll get every month or year. Stock prices fluctuate over time and day by day, but the stock prices of good companies reflect the value of the businesses.
How do you predict growth? Look at the historical performance of the company. The story it tells you about the possible future should be coherent. Just like you can look at your personal finances and figure out if you're doing well or poorly, you can get a sense of how a company is doing. (In most cases, you can pretty easily tell if the company might be a good value right now or not just by looking at a chart or two.)
When to Sell a Stock?
This isn't as easy to answer. It depends on your financial goals. If the price of the stock has gone up and you've made a nice profit, you may want to sell to reap that profit. If the money you invested would be better off in a different company, you might sell and reinvest the money elsewhere. Maybe you own too much of a stock, and your portfolio needs diversification to minimize your risk and optimize your opportunities.
Your financial goals will direct how you invest.
What are Good Financial Goals?
Some people want a comfortable nest egg when they retire. Some people want to pay for a new house or an education for their children. Some people want to quit their jobs and become volunteers at non-profit organizations. Some people want to minimize their taxes or take advantage of capital gains tax rates. Some people want a better yield than savings bonds.
Whatever your goal, figure out how much money you can afford to invest every month or year and stick to your plan.
How to Pick the Right Stock?
Even though it seems like the stock market is all about luck, remember that every stock ultimately represents a share of a company that sells cookies (or cars or insurance or airplanes or toothpaste). A good company is good at its business.
How do you pick a good stock? You already know good companies to invest in. You have an advantage if you stick to what you know! Find a great company you understand, one that makes money honestly and effectively. Find a company you'd like to own!
What Price to Pay for a Stock?
If you've found that great company, the question to ask is "How much should I pay for a share?" After all, the best way to make money is to sell for more than you paid for it.
That price depends on a lot of factors. Ultimately the right price for a stock depends on how much money the company can make for each owner and how much you're willing to pay to earn that money. This is the point at which half of the potential investors break out a spreadsheet and fill in lots of complicated formulas. (See the featured daily stock, for example.)
The best time to buy a stock is when it's at the cheapest price. The second best time is now, at least if it's available at a good price. Waiting for the absolute cheapest price is a recipe for inaction, and buying only the cheapest stocks is a recipe for disaster. However, the question of how to invest in the stock market with only a little money to start is easy to answer; buy a cheap and good index fund and squirrel money away regularly.
How the Stock Market Works
All of the articles in our How to Invest guide are written for novices. They don't assume you have an MBA or a brain full of investing jargon. All you need is a couple of hours a year and the willingness to take control of your financial future. You can learn how the stock market works and you can build real wealth in stocks over the long term.