Investing in Stocks for Absolute Beginners
By Dale Gillham | Published 15 January 2019
A lot of people have realised that exposure to the stock market provides a long-term solution to building wealth. Indeed, with the ease of access to technology and information, there has been a proliferation of individuals worldwide who have taken the bull by the horns and invested directly in the stock market.
For most people, their initial attraction to investing in stocks is based on a hot tip or because their friends were talking up the huge amounts of money they were going to make from the stock market. Unfortunately, the outcome for many of those who have invested this way has been one of disappointment because they either lost some or all of their capital given that they did not have the right tools to ensure their longevity in the market.
But this needn’t be the case if you educate yourself with some simple rules.
What is a share and how do I buy one?
In its simplest form, a share represents ownership in a company.
The best way to understand how the stock market works is to look at it like an auction, where there are bidders, a seller, and an auctioneer facilitating the transaction. The NYSE is the auctioneer. So if you have 5,000 people wanting to buy shares and 5,000 wanting to sell the same shares, the NYSE will match the buyers and sellers to exchange the shares at a specified price.
When looking to invest in a company, you are looking for stocks that are likely to rise over the medium to long medium. And while there are more than 2,800 companies listed on the NYSE, when starting out you should concentrate on investing in quality stocks that are highly liquid until you have gained sufficient knowledge and experience. This means you would be investing in shares from the top 20 to 50 on the NYSE.
When buying and selling shares, you will need to use a third party known as broker who is licensed by the stock exchange to facilitate the transaction on your behalf. Depending on your comfort level, you can use a discount broker, who simply executes any trades you place in the market, or you may decide to use an advisory broker who will provide you with advice or recommendations to invest in the stock market.
The brokerage costs will vary depending on the broker you use with prices ranging from as low as $5.00 for an execution broker up to 1 percent or more for an advice broker.
How do I make money from investing in stocks?
When investing in shares, you can make money in one of two ways:
- If the share price increases you will have made a capital gain if you sell the stock at a higher price. That said, it is important to remember if the share price falls from your initial purchase price you will lose money if you sell your shares.
- In some cases, you can also receive a share of the company’s profits in the form of a dividend, which is usually paid twice a year, although this will vary depending on each company. Bear in mind, not all companies pay a dividend but those that do see it as a way of rewarding their shareholders.
Isn’t my money safer in cash?
While investing in a term deposit is lower risk, they’re often not the best investment option, particularly when the dividends you receive from investing in shares can be around double the rate you receive on your savings. And if you consider the potential capital gains you will achieve if you pick your stocks correctly, you can see why investing in stocks is a better option.
Taking your first steps to investing in stocks
Before you invest in the stock market, it is important to understand why you are investing and what you expect to get out of it, as this will help you to work out your strategy and potentially avoid any irrational decisions down the track.
Therefore, beginner investors need to ask themselves a few key questions, such as:
- How long do I want to put money in the stock market for?
- How much am I going to invest?
- How many stocks do I want to hold?
- What is my tolerance to risk?
- How will I teach myself to invest?
It is important for anyone investing in shares to take the time to gain some knowledge and expertise before taking the plunge, otherwise, you run the risk of being someone who continually takes tips, but doesn’t know how to interpret the information.
The sooner you start to gain the knowledge and confidence in how to invest, the quicker you will get to a point where you will become independent.
It is also important to learn the basics about how the stock market works, which you can find on the US Securities and Exchange Commissions Investor website.
How much do you need to start investing in stocks?
While there is no definitive answer as to how much you need, you can start investing in stocks from as little as a $1,000, although you will need to start a savings plan so you can build up the number of shares you buy.
An important consideration when deciding how much you need to start investing in shares is the amount of brokerage you will pay on each transaction. For example, if you purchase shares worth $1,000 and you pay $20 in brokerage to buy and sell, the stock needs to rise by 4 percent or $40 for you to break even.
Understanding the costs involved should help you decide how much you want to invest in each stock.
How do you choose which stocks to buy?
When picking stocks to invest in, I always recommend the 50 largest companies on the NYSE because they typically represent the least amount of risk as they are highly liquid, well established businesses with a history of delivering steady returns, which is why they are known as ‘blue chip’ shares.
When selecting which stocks to buy, I always recommend basing your decision on both a technical and fundamental perspective. While many have a preference for using one form of analysis over the other, I use both as I find it narrows down the selection of stocks to a very manageable level. I outline these simple but powerful strategies in my latest book, Accelerate Your Wealth - It’s Your Money, Your Choice.
Once you gain the knowledge and experience to consistently profit over time, you can expand your reach out to the top 150 shares on the NYSE.
Cheap doesn't always mean a good deal
While some of you may be attracted to stocks outside the top 150, I highly recommended that you steer clear of buying penny dreadful stocks or small cap stocks because while they may look cheap at 10 to 20 cents a share, a small company with a shaky track record can wipe out all of the gains you have achieved on your portfolio as a whole.
Further, just because you can buy 5,000 shares at $0.20 each with your $1,000, doesn’t mean this is better value than purchasing 15 to 20 shares on a stock priced at $60. What matters when it comes to making money is not how many shares you own, it’s how much each share increases in value.
I would also caution you against buying shares just because the stock price is falling. A company may have announced a profit downgrade or a change in its situation that materially damages its future chances of making money, which is causing its share price to fall.
Before purchasing a stock, I highly recommend you look at a price chart to gain an appreciation of the historical performance of the stock. If the share price has been falling over the long-term, the company would most likely be considered a high risk investment. Most brokers provide you with basic price charts on which you can view the history of a stock.
How much are you willing to risk?
Before you invest in shares, it is critical that you consider how much you are willing to risk if the share price moves in the opposite direction to what you are expecting. The reason for this is that a lot of people know how to buy shares but very few know how to sell or when is the best time to sell.
To ensure you protect your capital each time you invest in a stock, it is important that you set a percentage stop loss of 10 to 15 percent depending on the volatility of the stock. This means deciding how much of your original capital you are willing to lose if the stock price falls after you purchase it.
And you need to commit to selling the shares if the stock price does fall; otherwise the losses in one company can wipe out the gains in the rest of your portfolio. Building discipline into the way you manage your investments from the outset is the key to your long-term success in the stock market.
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