To make money in the stock market, you must first understand what it is and how it works. In this article, we will guide you to a gradual and easy understanding.
Stock Market and Stockholders
A “market” refers to two groups of people: (1) those who want and can pay for a particular thing and (2) those who have and are willing to sell that thing.
“Stock” refers to ownership of a company. Think of a pie that’s sliced into 1,000 pieces. Individuals are given slices or buy them. Each slice is called a “share.” It represents a tiny amount of ownership in that company and a claim on that company’s assets and earnings. (In reality, that “pie” is usually divided into millions of shares.)
Not all companies make stock available to the public for purchase. When they do, it’s usually because they need to raise money to expand their operations, hire more staff, develop new products, or other reasons.
When you buy shares of a company’s stock, you become a shareholder in that company. Public individuals may own very large amounts of a company’s stock but the majority shareholders are usually the company’s founders, executives and family.
A stock exchange is where stocks are bought and sold. In some cases, like the New York Stock Exchange or London Stock Exchange, it’s an actual building—a place where stock traders work. Some exchanges, such as the NASDAQ, are not buildings, but are entirely computerized.
There are 20 major stock exchanges in the world and hundreds of others, across every continent but Antarctica.
How Is a Stock’s Value Affected?
Shares increase and decrease in value based on supply and demand—the number of shares that are available for purchase, how much the owners of the stock want per share and how much a buyer is willing to pay.
If a lot of people want to buy a stock, its price goes up. If a lot of people want to sell it, its price goes down.
What makes people want to buy or sell a stock? There are many possible factors, but for the most part it’s news stories and how they affect public perception of a company or an entire industry. (“Public” in this case means people who own or trade stocks.)
For instance, ABC pharmaceutical company announces that they’ve developed a drug that kills cancer. This news affects public perception of ABC. They see a strong company that will make a lot of money from this new drug. The demand for ABC stock increases. The price goes up. ABC shareholders watch as their shares increase in value. Those who want to sell their stock will have a high asking price for it. The number of shares available for purchase may be very low.
Two years later, news stories begin to appear about illnesses and deaths linked to the drug. A national law firm announces that it’s filing a class action lawsuit for wrongful deaths caused by the drug. Demand for the stock begins to drop. Public perception is that ABC is bad. People died. The company will take a big financial hit, perhaps paying out billions in settlements. They may have to recall the drug. Owners of ABC stock would seek to sell it quickly, before it lost further value. The supply of shares would increase and the value would decrease.
A more common example is news of a company’s quarterly earnings. When you hear on the news that “analysts predict” a certain company will have higher-than-expected earnings, that is often enough to cause the demand for the stock to increase along with its price. Then, when the company’s earning fall below that forecast, demand drops along with the price per share.
Okay, Okay … So How Do I Make Money?
This article deals strictly with choosing and monitoring your own stock investments, rather than working with a full-service broker or investment manager.
To have a chance to make money in the stock market, you have to invest. There are six steps to take:
1. Browse Yahoo! Finance.
Or another financial site and see what’s happening in the market. Look for stories about specific companies. Are their shares moving up or down? What reasons are given? Begin to familiarize yourself with the various stock-related terms that are used.
2. Do some paper trading for a few months or a year.
3. Buy a few shares.
Nothing increases your interest and commitment like having some “skin in the game.” Open an account with an online discount broker such as Options House or ScottTrade and purchase a small number of shares, preferably of a company whose stock is trading in the $1-to-$5-per-share range. This is just a step up from paper trading rather than a major financial risk.
4. Monitor your buys and see how their value fluctuates.
Review the long-range stock charts for each company you’ve invested in. Do you notice trends, such as repeating rises and drops over a long period?
5. Continue to study the market.
Read about the companies you’ve invested in. Review long-range charts. You will get a better understanding of how the market works, how slowly or how fast changes can occur, etc.
6. Make larger and more well-informed stock purchases.
What Goes down Must Come Up
There are two kinds of people who seek to make money in the stock market: investors and traders. Their distinct characteristics and strategies are determined by their financial goals and their tolerance for risk.
Investors buy and hold a stock, perhaps for decades. They are not disturbed by the daily, weekly, or monthly fluctuations in the market that can affect the value of their stock. They are investing for the long-range increase in value.
There are several styles of traders, but none of them hold a stock for very long. Though a stock’s value may be on a two-year downtrend, on a daily or weekly basis, it rises and falls. It is during those daily or weekly fluctuations that traders seek to make their profit.
Profiting from a Falling Market
Traders don’t always seek to make money from an increase in a stock’s value. They can also make money when its value falls. This is called “short selling.”
For instance, XYZ Computer stock is selling for $40 a share. Trader Bob just read about slow sales of Orange’s latest gadget. He now believes that Orange’s stock is going to have a dramatic drop in value.
Bob can “borrow” 500 shares of Orange from his broker, sells them to a buyer for $40 per share and makes $20,000.
Let’s say Orange’s stock falls to $35 a share. Bob can then purchase 500 shares at that price per share for a total of $17,500. He gives the shares back to his broker and pockets the $2,500 profit.
There are a lot of resources that promise to teach you how to become successful in the stock market, but there is no substitute for your own experience. Continue to learn and observe the market. Approach your investing gradually and never invest more than you can afford to lose.