What do you do with extra money that you have left after paying your bills? You can choose to put it in the bank like most people would or invest it in financial instruments. The latter option holds a higher risk and will involve time and effort on your part, but it has higher returns. If you are not risk-averse, you can generate extra income by investing in stocks. Let’s take a closer look at this opportunity and how to get started.
Understanding Stocks and the Stock Market
Stocks are shares of publically traded companies. When you buy them, you gain equity in the respective companies. This entitles you to part ownership and a share of the entities’ earnings. If a particular entity is dissolved, the shares give you the right over an equivalent portion of its assets.
There are two types of stocks. If you own common stock, you will be entitled to voting at the annual shareholders’ meeting, but receive no guarantee on dividend payment. If you own preferred stock, you will not have voting rights, but your dividend will be guaranteed.
The stock market is the place where buyers and sellers meet to exchange securities for money. Currently, there are both physical and virtual exchanges with the latter gaining speed as transactions are easier, quicker and more cost-efficient when made electronically. As an investor, you will most commonly trade stocks in the so called secondary market where the exchange is between third-party players – neither the seller nor the buyer is the company which has issued the stocks.
In this market, the price of stocks is determined by supply and demand. Higher supply (more stocks available for sale) pushes prices down while higher demand (buyers seeking to buy more stocks) pushes them up and vice versa. The tricky part is to figure out what the driving forces behind supply and demand are.
Risk and Returns
What do people mean when they say that stocks are volatile? This means that the stock prices are sensitive to a wide variety of factors. They are affected not only by the value and financial performance of the particular company, but have many other influencers from the macroeconomic situation to natural disasters and even rumors. This means that it is hard to predict the changes in prices and this naturally creates risk.
Before you invest in stocks, you need to have a clear idea of the size of the risk involved. If the price of a stock goes below the price which you have paid for it, you will lose only the difference, provided that you decide to sell at the lower price instead of keeping the stock based on expectations that its price will go up again. The only way to lose all of the money which you have put in is for the company to go bankrupt, but this is extremely unlikely to happen without warning signs which would make you act quickly and avoid major loss. In general, the main tactic for offsetting risk is to diversify your portfolio – to hold stocks from multiple companies with different characteristics.
It is natural for people to think that they will make money only by selling a stock for a higher price when it is in high demand. However, it is more productive to think about stock investment as investment in an asset such as a house, for instance. When you create a portfolio with multiple stocks and manage it successfully by making sales and purchases, the value of this asset will increase over time. Even though the annual dividend per share is typically small, this is also income which you will receive when holding stocks.
The Technical Side of Investing
Now that you have a pretty clear idea of the actual way of making money with stocks, we need to focus on the technical matters. How do you get to buy company shares in the first place? You have to do this through a broker by creating an account. There are generally two types of brokerage services.
The full brokerage service includes investment advice while the discounted one includes only the making of transactions on your behalf. It may seem more logical to pick the first option, especially when you are a beginner, but it is important to note that there is no guarantee that your broker will offer the best advice to you. With a discounted brokerage service, you will be on your own when it comes to making decisions. The broker will only fulfill your buying and selling requests.
Investment Size and Costs
In order to create an account with a broker, you must put in a minimum sum. For full-service brokers, the account minimum could be tens of thousands of dollars. Discounted services have much lower minimums, especially those available online. You can start with as little as $1,000. You should definitely consider your current financial situation and risk nature in addition to these restrictions before deciding how much money to invest initially.
When selecting a broker, you should also check their commissions. This is important since every time you buy and sell stocks, you will have to pay a fee. It is worth pointing out that the fee is applicable to shares of a single company. If you want to purchase shares from three different companies, for example, you will pay three times that fee. You should calculate and budget your trading costs to ensure that you will be on the profitable side.
Trading as a Business
While you can rely entirely on your full-service broker or on a separate financial advisor for managing your portfolio of stocks, it is best if you learn how to invest yourself. This will help you keep risk down and make more money. The question is how to get started. The first step is to view investment as a business.
To do well in this business, you first need to learn how to analyze and valuate stocks. This will enable you to make the best buying and selling decisions. Fundamental analysis is focused on the individual performance of a company. As its name suggests, it is essential for identifying company value which is the main determinant of stock value.
To analyze company value in detail, you will need to learn how to read and extract useful information from financial statements including profit and loss statements, cash flow statements and balance sheets. In general, stock prices are very sensitive to quarterly earnings, which public companies are obliged to announce, so you must watch out for those. Additionally, you need to keep in mind that the future value of the company is a major determinant of its stock value too. That is why your analysis should be focused on prospects (newly released products, projects, development plans) as well as on historical data.
Technical analysis is intended to help you predict the movement of stock prices based on market factors entirely. As its name suggests, its goal is to identify patterns and models for the fluctuation of the market prices. The idea is to figure out which direction prices will move in and what the size of the change will be when a specific factor is present.
What are you waiting for? Learn the basics of stock investing in advance and get some practice without using money in the first place. This will help you to avoid costly mistakes and build a strong portfolio.