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Updated on Thursday, January 16, 2020
Learning to trade stocks can be an excellent way to build long-term wealth. There’s a reason why the news reports on the stock market all the time — after all, it’s one of the most important parts of the economy. But if you’ve never traded stocks before, all this information can seem confusing and overwhelming. How do you even get started?
This beginner’s guide provides the basics on how to trade stocks. Whether you’re investing for the very first time or just need a refresher of the key concepts, we’ve covered them here.
What is a stock?
A share of stock represents a small ownership stake in the business. When a company such as Amazon or Nike needs money but doesn’t 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 — a part owner, in other words — and are entitled to a cut of the company’s profits. Some companies send cash directly to their stockholders, called a dividend payment, giving them their share of the year’s 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 — also called a secondary market — like the S&P 500 or Nasdaq. When investors buy and sell shares on the stock market, it’s 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.
How do you trade stocks?
- Brokerage account: A brokerage account lets you buy and sell stocks and other investments. You can open one with online stock brokers, transfer money to your brokerage account and figure out which trades you’d like to make. This is the most do-it-yourself approach to trade stocks.
- Mutual funds/ETFs: Rather than buying individual stocks, you could also buy mutual funds and exchange traded funds (ETFs). These are portfolios of stocks managed by a professional investor. When you buy in, you automatically get a share of a large, diverse portfolio so you don’t have to plan it together yourself.
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. “A person can get exposure to the 500 largest companies on the NYSE with just one fund,” 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.
- Financial advisor: If you’d like more help, you can also hire a financial advisor to suggest stocks or even manage the portfolio on your behalf. You’d need to pay them an additional fee for this advice. Some charge by the hour while others could charge a percentage of your portfolio, like 1% of your account balance each year.
- Robo-advisor: Combining aspects of conventional financial advisors and brokerages, robo-advisors use computer algorithms to recommend stock portfolios based on your goals and preferences. They charge management fees, but they’re usually less expensive than hiring a financial advisor.
How do you invest with stocks?
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:
- Time horizon: How soon will you need your money back? If retirement is decades away, you can afford to take more risks with your stocks, perhaps buying stocks of smaller companies with more growth potential. But if you need money in a few years, you’d likely want to play it safer by purchasing stocks of more established companies, known as blue chips.
- Risk tolerance: Imagine your stock portfolio lost a bunch of money today — 10%, 20%, even 50%. How would you feel? If losing money would really rattle you, it may be better to use safer stocks and even keep more money in cash or bonds. On the other hand, if you are OK dealing with short-term losses in exchange for higher future gains, you could be a better fit for riskier strategies like day trading.
- Target return: How much do you hope to grow your money year after year? Investing is a trade-off between risk and return. If you want to earn more, you may need to take more risks and buy stocks with more growth potential, rather than proven blue chip companies. Just know that aiming for a higher return increases your chance of losing money.
- Income needs: Do you need cash coming in from your stocks right away? Consider high-dividend stocks that pay out more now. In exchange, their price likely won’t gain value as quickly as growth stocks, which reinvest profits so the company hopefully earns even more in the future.
- Amount to invest: What is your investment budget per year? Some brokerage accounts, funds and financial advisors require at least a minimum investment, for example, you may need at least $10,000. Your budget could determine your investment options.
- Other investments: What are you doing with the rest of your savings? If it’s in safe places like cash or bonds, you could potentially afford to take more risk with your stock portfolio. On the other hand, if your money is in gold, real estate and other potentially riskier investments, you may want to be more conservative with your stocks.
How do you decide which stocks to buy?
With your goals in-mind, you can start reaching which stocks to buy. Now, without a crystal ball, it’s 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 CFP® and financial advisor based in Massachusetts, recommends that you keep it simple. “Invest in companies that you know and that a third grader can understand.”
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.
Research companies before you buy their stock
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 don’t overlook your local library. “Most library systems have access to Valueline, CFRA and Morningstar. These companies do not make markets in securities, so their research is pure.”
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 don’t put all your eggs in one basket. For example, let’s 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.
What’s the difference between day trading and investing?
As you figure out your strategy, you need to decide whether you’d like to day trade or invest for the long-term. Day trading means you’re buying and selling stocks frequently throughout the day based on the most recent news. Investing in stocks takes a longer-term horizon and you’re 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, you’re also trying to outmaneuver all of Wall Street. As a result, making money with day trading can be stressful and challenging.
Investing may be a better strategy
The financial advisors we spoke with for this article all came out in favor of investing as a more profitable strategy. “Too many people hear a hot tip, jump in, and check the stock every five minutes. My mantra is ‘Become the owner of a company, not a trader’,” said Harris.
Harris also recommends patience with your picks and that you shouldn’t sell at the first hint of bad news. “I 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.”
Where can you get help buying stocks?
If investing in the stock market for the first time seems intimidating, well that’s because it can be. There’s 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 it’s 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.
“For 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,” suggests Clark Randall, CFP and founder of Financial Enlightenment based in Texas. “After the planning phase, they can either invest themselves or hire the planner to implement the recommendations.”
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.