Learning to trade stocks can be an excellent way to build long-term wealth. Thereâs a reason why the news reports on the stock market all the time â after all, itâs one of the most important parts of the economy. But if youâve never traded stocks before, all this information can seem confusing and overwhelming. How do you even get started?
This beginnerâs guide provides the basics on how to trade stocks. Whether youâre investing for the very first time or just need a refresher of the key concepts, weâve covered them here.
A share of stock represents a small ownership stake in the business. When a company such as Amazon or Nike needs money but doesnât want to take out a loan, they can sell stock to investors.
When you buy a share of stock, you become a shareholder of a company â a part owner, in other words â and are entitled to a cut of the companyâs profits. Some companies send cash directly to their stockholders, called a dividend payment, giving them their share of the yearâs earnings.
Investors also make money by buying stocks, waiting for them to become more valuable, and then selling them. While you can buy shares of stock from a company directly, the most common way to buy and sell stocks from other investors on a stock market â also called a secondary market â like the S&P 500 or Nasdaq. When investors buy and sell shares on the stock market, itâs called trading stocks.
The price of a stock changes every day based on how people think the company will do. If its future prospects look good, the price will likely go up. If a company gets bad news, its stock price could go down.
Peter Creedon, a CFP and the CEO of Crystal Brook Advisors in New York, thinks this is a solid approach for beginners or investors with limited funds. âA person can get exposure to the 500 largest companies on the NYSE with just one fund,â said Creedon. He also recommended that beginning investors build exposure to many companies and possible sectors of the market, before going after an individual stock.
Before you start putting money in the stock market, you need to figure out your investment goals. Some of the main factors to consider include:
With your goals in-mind, you can start reaching which stocks to buy. Now, without a crystal ball, itâs impossible to know ahead of-time which stocks will earn a great return. But there are strategies that can help you chances.
Bill Harris, a CFPÂŽ and financial advisor based in Massachusetts, recommends that you keep it simple. âInvest in companies that you know and that a third grader can understand.â
A different strategy would be to target sectors where you have specialized knowledge, because this can give you an edge versus the average investor. For example, if you have a science or medical background, you could focus on pharmaceutical stocks.
Putting in the proper research is also important as you figure out which companies will succeed in the long-haul. The internet and TV are full of financial news but Harris says donât overlook your local library. âMost library systems have access to Valueline, CFRA and Morningstar. These companies do not make markets in securities, so their research is pure.â
Another useful strategy is to focus on diversification, also called asset allocation. This means you buy a mix of stocks and other assets so you donât put all your eggs in one basket. For example, letâs say you buy both car and oil stocks. If the price of oil goes down, that might be bad for oil profits but could lead to customers buying more cars. As a result, your car stocks go up and balance off your oil stock losses.
Finally, you could use a stock market simulator to test your strategy without taking any risk. These tools let you virtually invest in stocks with play money, so you can see whether your ideas would be successful before you commit your actual savings.
As you figure out your strategy, you need to decide whether youâd like to day trade or invest for the long-term. Day trading means youâre buying and selling stocks frequently throughout the day based on the most recent news. Investing in stocks takes a longer-term horizon and youâre buying stocks and holding them for months, even years.
While day trading may seem more interesting, it does have its downsides. Each time you buy or sell a stock, you need to pay trading fees. You could also owe higher income taxes on your stocks, as the IRS charges a higher tax rate on short-term gains, stocks that you sell within a year of buying. Not to mention, youâre also trying to outmaneuver all of Wall Street. As a result, making money with day trading can be stressful and challenging.
The financial advisors we spoke with for this article all came out in favor of investing as a more profitable strategy. âToo many people hear a hot tip, jump in, and check the stock every five minutes. My mantra is âBecome the owner of a company, not a traderâ,â said Harris.
Harris also recommends patience with your picks and that you shouldnât sell at the first hint of bad news. âI commit to staying invested in each position for at least one year. One year from now before I even look at the stock performance, I will make the decision if I still feel the same way about industry and that company. At that point, I will either sell or buy more.â
If investing in the stock market for the first time seems intimidating, well thatâs because it can be. Thereâs a ton of information to learn, especially if you try to do everything by yourself. As a beginner, consider getting some help with your first trades. Whether itâs working with a live financial advisor, a professionally mutual fund/ETF or even a robo-advisor, all these methods would get you started on the right foot.
âFor beginners, I would recommend they hire a certified financial planner to prepare a financial plan, understand their risk profile and set up an overall target allocation,â suggests Clark Randall, CFP and founder of Financial Enlightenment based in Texas. âAfter the planning phase, they can either invest themselves or hire the planner to implement the recommendations.â
Learning how to trade stocks takes some work, but the returns could be well worth it. Between the information in this guide and the support of a professional advisor, you can feel confident about investing in stocks, even as a beginner.