If you’re not too familiar with stocks, maybe the words “stock market” make you think about investors on the floor of the New York Stock Exchange shouting orders under a scrolling LED screen of green and red arrows and numbers. Or maybe you’ll think of day traders who stare at stock charts all day making split second buy and sell decisions involving thousands of dollars.
Regardless of where you’re coming from, in this post I hope to clear up any misconceptions you have. I want to give you the facts about what the stock market really is and tips on how you can get started investing in stocks.
This is information compiled from my experiences learning how to trade stocks (as an average person) and the questions that were going through my head when I was getting started. This post has everything I wish I knew and answers all the questions I had when I was first getting into stocks.
Special thanks to Jenny (a smart person) for helping me write this article.
A stock is a type of investment that represents an ownership share in a company.
When you purchase a company’s stock, you’re purchasing a small piece of that company, called a share, and you become a shareholder.
Investors purchase stocks in companies they think will go up in value. If their stocks go up in value, the investors make some money. For example, if an investor bought a stock at $50 per share and it went up to $55 per share, the investor would have received a return on investment of 10%. That’s a gain of $5.
For companies, issuing stock is a way to raise money to grow and invest in their business. When investors buy their stock, the investors’ money is now in the company’s hands to do as they please. However, the company must spend this money wisely or else the investors could start pulling their money if they fear the company isn’t managing their money well.
Stock prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. On the other hand, if more people wanted to sell a stock than buy it, then the price would fall.
It’s not too hard to understand how supply and demand work, but it’s hard to understand the root cause of why people like and dislike a stock. A simple, high-level explanation is that the price movement of a stock indicates what investors feel a company is worth. However, a more in depth analysis might point to economic factors, financial status of the company, competition in the market, overall outlook of the industry, political developments, etc..
If you wanted to know the price of a certain stock, it’s pretty easy to look up that information. Most stocks have a code that you can use to look up it’s price. For example, if you wanted to look up the stock price of Facebook, you could search “FB” on a stock price checker or just Google “FB stock price”. If you don’t know the code, you could just Google the company’s name + “stock price” and probably find the same information.
Some stock charts use markers called “candlesticks”. These candlesticks tell you more information beyond the price of a stock at the end of the day. Candlesticks will also give you information about the stock price when the markets opened (9:30 AM EST), when the markets closed (4:00 PM EST), when the stock hit its highest price for the day, and when the stock hit its lowest price for the day. Light candlesticks mean the price went up during that day since opening while red/dark ones mean the price went down.
Each candlestick typically represents a day. They can also represent smaller or longer units of time such as hours, weeks, or even seconds. The unit of time you choose will depend on how often you plan to make trades. If not very often, you would choose days or weeks. If you’re getting into day trading (which I don’t recommend), you might choose seconds or minutes.
Here’s what the candlesticks might look like plotted on a chart:
The words “stock market” have two meanings.
First, it refers to literally the market for stocks – where investors buy and sell their share of stocks. Investors can buy and sell stocks among themselves through stockbrokers. Nasdaq and the New York Stock Exchange (NYSE) are the two largest stock exchanges in the world. These two stock exchanges are open weekdays from 9:30 AM EST to 4:00 PM EST excluding holidays. Stock trades can be placed outside of those hours, but won’t be officially ordered until the market next opens at the market open price.
Second, when people refer to the stock market being up or down, they’re generally referring to the stock market index. A stock market index is an index that measures the performance of a stock market. It’s just a calculation of the prices of selected stocks. An Index helps investors compare current price levels with past prices to calculate market performance. In the U.S, the most popular stock market indexes are the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Stock Market Composite.
The short answer is investing in stocks should (in theory) give you higher returns on your money than keeping it in a savings account. From historical records of the S&P 500, the stock market has demonstrated an average annual return of 10%. Compared to an average inflation rate of roughly 2.5%, a 10% annual return is definitely giving you a solid return on your money.
From the chart below, you can see the annual return of the S&P 500 each year. Just to be clear, this isn’t a rolling average, each bar represents the return of one single year of S&P 500 price movement.
You could easily go down the rabbit hole of why you should invest in stocks rather than real estate, bonds, options, futures, etc., but long story short, stocks are just one way you can invest your money.
The short answer is yes, there is some risk involved when you invest in the stock market. If you look at the chart above you’ll see some years where the annual return went negative (the red bars). So if you decided to invest in stocks one of those years and sold at the end of one of those years, you would have lost some money.
Stock returns can be volatile (vary a lot) short term, however the data shows they are reliable long term. The historical data shows that the longer you stay in the market, the more likely you will receive a return on your investment. Here’s a chart that shows the chance you might lose money in the stock market. The risk strongly depends on how long you plan to invest your money in stocks:
Even though there are some risks, it doesn’t mean it’s a bad choice to invest in the stock market. Everything has risk associated with it. If you invest in real estate, there’s a risk your property could burn down or bad neighbors move in next door causing your property to lose value. If you lend money to someone with interest, there’s a risk they could simply never pay you back. Even if you take a walk down the street, there’s a risk you could trip, fall, and die.
What is more important to think about is how much risk are you willing to tolerate and for how much reward you are expecting to get in return. You could invest in a startup and become one of the first (and biggest) investors in the company, but risk the startup failing (high risk, high reward). You could also choose to save all your money in a savings account and collect interest (low risk, low reward). It all depends on your personal risk tolerance. That’s something you will have to decide for yourself.
In terms of the stock market, there is definitely higher risk if you engage in short term trading. However, if you invest your money and keep it there for years at a time, the historical data shows you have a pretty high chance of getting a return on your investment.
Since there’s no minimum to get started trading stocks, you can effectively start trading anytime you like. However, I do have some suggestions if you were thinking about putting serious money into stocks. Here’s a list of things you should check first:
If you answered yes to all of those questions, then I think you are ready to start investing serious money in stocks. In my opinion you should start as soon as possible. You want to maximize the length of time you can take advantage of stock market returns.
Even if you didn’t answer yes to all those questions, I still think it’s a good idea to put at least a few dollars in the stock market just to get your feet wet. I suggest you make your investing mistakes early on with just a few dollars rather than with your entire life’s savings.
The vast majority of people do their trades through some kind of online broker. There are also a few other options available for you to start trading stocks.
Here’s a list of some broker types to consider when deciding how to manage your stocks:
There is no minimum amount needed to start investing in stocks (at most online brokers). Most online brokers do not require you to have a minimum amount to open an account.
However, one thing to be aware of is commission rates relative to your investment amount. If your broker charges you $5 per trade and your investment amount is $50, you immediately lose 10% of your investment just from commission fees. On the other hand if you’re starting out with $50,000, a $5 commission fee is only 0.01%, a very small percentage of your investment. I recommend having at least a few hundred dollars to start with if your broker is charging you commission.
If you have just a few hundred dollars or less, you will want to start with a commission-free broker. This way you can get your feet wet with trading stocks without worrying about losing your money to commission fees.
Another option you can think about is trading with fake money. Some brokers will allow you to start with fake money just to see how your investment strategy will play out. If you’re just learning how to get into stock trading, this might be a good way to get a feel for how things work without risking your real money.
One small note if you start with fake money: the psychology is different trading fake money vs. real money. Maybe you might think you can just mentally power through it (as I did). But, you never truly know how you’re going to act until you actually get into that situation. Fake money practice can help with intellectually understanding the stock market. But, I believe that playing with real money is where the real learning takes place.
How much of your personal savings you should invest depends on many factors, like your income, spendings, retirement plans, risk tolerance, etc. Also, stocks are just one type of investment. There are many other investment options available such as bonds, mutual funds, commodities, etc., that have their own risks and returns. I might write another article about how to choose an investment type, but here are some important guidelines when considering your own financial situation:
There are probably thousands of books and millions of articles that have been written to answer this question. There are all sorts of strategies to choose from when trying to pick the right stocks to buy. You can look at the company’s quarterly earnings reports, price to expense ratios, stock patterns, technical analysis, breaking news, etc..
The truth is there is no method that will guarantee you will always pick the right stock. I guarantee you it doesn’t exist (unless there’s a time machine out there). There may be certain strategies out there that will help you be more profitable. However, you have no way of knowing which one will give you the most returns, despite what people might tell you.
It may be tempting to dive into researching all sorts of different trading techniques and upcoming hot stock picks. However, doing so will not guarantee you will get better results. In fact, having too much information may lead to overconfidence and information bias. Even the experts can’t beat the market, why would you?
Giving a complete answer to this question is probably out of the scope of this article, but here are my two cents on this:
It might be tempting to try to figure out a way to beat the market using some secret trading technique. Looking at previous stock price data, it looks like you could buy at the dips and sell at the peaks to get a massive return.
The problem with that logic is that you have no idea when you are in a dip or a peak today, right now. A pattern that may appear to be a dip according to past data could actually be the start of a long bear run (steady price decline). If you buy at that time, you could lose out big time. Similarly something that looks like a peak could actually be the start of a long bull run (steady price increase). If you sold then, you would lose out on all the potential gains.
Studies have shown that more active traders actually get lower returns on their investment over time. Many active traders will make precisely the wrong moves that will cost them in the long run. They might in fact buy when stocks are high (believing they will go higher) and sell when they are low (believing they will go lower). They might sell when they’ve made a small gain (missing out on future gains) and hold onto stocks hoping the price will go back up (not cutting losses short).
You also need to consider the time it will take to master a certain trading technique. In order to master a trading technique, it takes serious discipline. You need to make robotic, logical choices and turn off your emotions. Easier said than done. It might take years of practice (and lost money) to get good enough to even get modest returns using these techniques.
My suggestion is to just try to match the market, not beat it. There’s absolutely nothing wrong with getting average results when you’re talking about investing. According to the historical data, if you’re getting an average return you should be getting a 10% return on your investment per year. That’s already a great return on your investment. You would be doing pretty good for yourself.
If you buy your stocks and don’t sell them for a long time, the data shows you should be fine long term. However, if you try to time the market or try buying low, selling high (which I don’t recommend for beginners), you will take on a much bigger risk of losing out on your investment. I tried that when I first started and it did not turn out so good for me. I think I lost half my money in the stock market back in those days.
I hope this post answered any questions you might have had about getting started with trading stocks. The key here is to just get started and play the long game. Don’t try to time the market or pull out because of some bad news you heard about. The data shows that investing long term is a reliable strategy for getting a return on your investment.
If you’re interested in more money tips, check out some of these articles:
When you buy a stock, it seems like your money disappears into the ether and…
When it comes to saving money, a lot of youngsters think of saving as something…
Got a friend who owes you money that always seems to “forget” to pay you…
Budgeting, budgeting, budgeting. You hear it everywhere you hear any personal finance advice, whether that…
Is it ethical to invest in the stock market? For most stock investors, this might…
Are you getting tired of having to choose between eating out or spending time and…
View Comments