When you think of investing, your mind probably immediately jumps to stocks. But what are stocks exactly, and how are they traded?
If you want to learn how to invest in stocks, this comprehensive guide will help you understand the basics and learn how to get started.
What are stocks?
When you buy a stock, you are purchasing a small portion of a company. It means you have claim on part of a company’s assets and earnings. Your ownership percentage depends on how many shares of stock you own and how many shares are outstanding.
For example, Coca-Cola (KO) has a little more than four billion shares out there. If you own 1,000 shares in KO, your ownership percentage is very small.
However, your ownership percentage isn’t a big deal when you’re using stocks in your portfolio. What matters more is the fact that you have shares. So when stock prices go up, you can capture the gains. On top of that, your ownership of shares entitles you to dividends when they are paid out.
Preferred vs. common stock
There are two main types of stock. Common stock is what you are most likely familiar with. When you trade stocks on an exchange, you usually buy common stock. You buy the stock, you are entitled to a vote at shareholders’ meetings, and you can receive dividends. If you are eligible to vote because of stock you own, the company will let you know.
Preferred stock doesn’t usually come with voting rights. However, with preferred stock, you have first claim on earnings and assets. If a company goes bankrupt, preferred shareholders are in line to be compensated ahead of common stockholders.
Dividend stocks represent a portion of company profits. You share in those when companies choose to pay them.
Some companies pay dividends regularly, such as every month or every quarter. Other companies choose to pay semi-annually or annually. There are also companies that only pay dividends on occasion. They decide every now and then to share out dividends when they have a particularly large number of assets or high earnings.
In some cases, companies don’t pay dividends at all. If you’re interested in dividends, check a company’s history to see how they handle dividends.
How stock buying and trading works
When you’re investing in stocks, you’re actually buying on the secondary market. In most cases, you’re purchasing stocks from someone who already owns the shares and is willing to sell them.
The basic mechanics of a stock trade work like this:
- You instruct your broker to purchase a certain number of shares of a specific stock.
- The broker sends an order to the exchange floor representative.
- The floor trader finds another trader who’s will to sell the stock you want.
- Both traders agree on a price and the exchange is made.
Of course, when you use an online broker, it all happens in the blink of an eye. No one in an electronic transaction has to physically meet and agree on a price. A computer takes care of everything.
Interestingly, the New York Stock Exchange (what you probably picture when you think of Wall Street) still completes a large number of transactions physically. The NASDAQ, on the other hand, manages all of its trading electronically.
The good news is that it’s not hard to use a broker. There are plenty of online discount brokers that offer access to electronic trading systems from your computer (or even your phone).
Stock trading hours
In general, regular trading hours are 9:30 a.m. to 4:00 p.m. EST, Monday through Friday. There are after-hours trading sessions that take place between 4:00 p.m. and 8:00 p.m. EST. There are also some brokers that offer early morning trading for a couple hours before the regular opening.
It’s important to understand that there isn’t much liquidity during after-hours trading and prices can fluctuate more. Many brokers will only allow you to trade listed stocks. That means you can’t buy or sell bonds, funds, or penny stocks during after-hours trading.
If you’re just starting out, it makes more sense to limit trading to regular market hours.
How are stock prices set?
For the most part, stock prices are set using supply and demand. If more people want to buy a stock than sell it, the price goes up. However, if more people are interested in selling, the price goes down as sellers discount the amount they are willing to take just to get someone to buy.
There are many factors that influence how people view a stock and its desirability, however. If a company reports worse than expected earnings, fewer people might find the stock attractive and the price drops to attract more buyers. If a company shows strong growth, the price rises as more people decide they want to own a piece of the company.
Other factors can influence stock prices in general. Some of these factors include:
- Economic conditions
- What’s happening with the credit market
- Concerns about geopolitical situations (making people more nervous to own stocks in general)
- How large institutional investors, such as college endowments, buy and sell their own holdings
When you have a basic understanding of how prices can move, you can get a feel for trends. However, it’s still difficult to try to time the market. In the end, no one can predict the future — even the experts don’t know for sure what will happen next with any given stock or the market in general.
What is a stock quote?
When learning how to invest in stocks, it’s important to understand what a stock quote entails.
A stock quote is the current price of a share. When you use an online broker with a free account, you’re likely to get a slightly delayed quote. This doesn’t normally matter when you’re buying stocks that you plan to hold onto. For most beginning investors, you won’t be trading frequently enough to need real-time quotes.
Real-time quotes are usually available when you pay for an upgraded subscription service from your broker. Because stock prices are always changing, the exact quote can change many times over the course of a few hours. If you are day trading, these fluctuations matter more.
Sample stock quote
If you want to check a stock quote, there are plenty of places to find the information, from Yahoo Finance to searching in Google. When looking at a quote, you will see the name of the company, followed by its ticker symbol in parentheses.
Some of the information you find when you look at a stock quote includes:
- Current stock price (delayed quote). In this case, the stock’s price is $43.22 per share.
- How much the stock is up (or down). This stock has gained seven cents since the day’s open.
- After-hours movement. If you’re looking after the close of the stock exchange, you will see the after-hours movement. In this case, KO has gained another three cents since the market has closed.
- Previous close. This looks at the closing price for the previous day. Here, the closing price was $43.15. However, the opening price on the following day might not be the same. Due to after-hours trading, changes may mean that an open price is different from the previous day’s close price.
- Market cap. This is the value of a company’s outstanding shares. All of KO’s outstanding shares together equals $184.66 billion.
- Performance chart. This shows the year-to-date performance of KO. When using an interactive chart, you can see performance for different time periods to get an idea of trends for that particular stock.
There’s other information you can see from a stock quote online, too, including dividend yield and payout. But the basics are all listed above. Some of the information might seem overwhelming at first, but as you continue to learn more about investing in the stock market, the numbers will make more sense.
How to open an account with an online broker
When you’re ready to start investing in the stock market, it’s time to open an account with an online broker. Many online brokers don’t set account minimums, so you can start investing with a small amount of money.
To open an account, you’ll need the following information:
- Phone number
- Driver’s license
- Social Security number
- Bank account and routing information (to fund your investment account)
In most cases, you can set up your account in a few minutes. Then you’re able to start trading a few days later, after money is transferred from your bank account to your investment account.
If you want to choose stocks and create a portfolio on your own, you can open an account with a more traditional discount broker. Companies such as E*TRADE, Scottrade, Schwab, and TradeKing can all provide what you need.
If you want to invest, but don’t have a clear idea of what you should invest in, you can use a robo-advisor such as Betterment, Wealthfront, or FutureAdvisor. All of these brokers use formulas that build a portfolio for you using stocks and bonds they automatically choose on your behalf.
How to choose stocks for your portfolio
Once you have a brokerage account, you can begin buying stocks and building your portfolio. When deciding what makes a good investment, there are a few things to consider. As a beginner, start with the fundamentals.
Consider the company’s history
Look at the company’s history. Does it have a record of long-term growth? While past results can’t predict the future, you can get an idea of the general health of the company over time. If the company has seen growth over the long-term, even if it’s somewhat boring and steady growth, it is likely a solid choice.
Another consideration is the way the company is managed. Do the executives make good decisions? Are they competent? Don’t forget to look at a company’s profit margins and earnings, and compare those numbers with other companies in the same field. Is the information in line with similar businesses? Is it better or worse?
Look at the P/E ratio
One measure that many long-term “value” investors look at is the price-to-earnings (P/E) ratio. This number is a quick way to see the current share price relative to its per-share earnings. The P/E ratio looks at the current price divided by the earnings per share.
Earnings per share can be figured in different ways. Some calculations look at a company’s earnings for the last four quarters (trailing P/E). Others use a prediction of earnings for the next four quarters (forward P/E). Finally, there are measures that combine the last two quarters with estimates of the next two quarters.
Let’s use KO as an example. The price of KO is $43.22. KO has gone up $1.42 in the last 12 months. Divide the current price ($43.22) by the earnings per share ($1.42), and you get a P/E ratio of 30.44.
You have to compare the P/E ratio to other companies in the same sector, though. Pepsico (PEP) has a P/E ratio of 24.19.
In general, a higher P/E ratio compared to other companies indicates an expectation of higher growth in the future. However, a lower P/E ratio could mean the market is undervaluing a company. If that’s the case, you might get a bargain if you buy a company with a low P/E ratio.
Build a diverse portfolio
Your portfolio should contain stocks from different areas, or sectors. Don’t buy all energy stocks or all healthcare stocks. Different sectors tend to gain or lose at different times; a time when utility stocks are up might be a time when retail stocks are down.
If you have different types of stocks in your portfolio, you are more likely to be insulated from the market’s ups and downs. Even if one type of stock is lower, others in your portfolio may be gaining, helping you see increased value overall.
However, if you have a small amount of money, it can be difficult to build a diverse portfolio using individual stocks. You might not have the money available to buy multiple shares of several different stocks from various sectors.
Invest in funds
The market isn’t perfect and participants in the market are sometimes irrational. The future is unpredictable and you might not be able to properly diversify your investments. Until you get the hang of buying stocks, investing in funds might be a better option.
A stock fund is a collection of stocks. Instead of choosing individual stocks, you invest in a collection of equities that share characteristics. A fund might be made up of certain types of dividend stocks, stocks with a high rate of growth, or stocks that are on the same index (more on that below).
With a stock fund, you get a little piece of everything included in the fund, which allows your investments to mirror a wider swath of the market. It’s instant diversity available for a relatively cheap price and is considered a good strategy for beginning investors.
Choose index mutual funds and ETFs
One popular way of investing in stocks is to choose index mutual funds. These follow indexes.
An index is a measure of a group of stocks that share similar characteristics. For instance, the Dow Jones Industrial Average is a measure of 30 large companies trading in the U.S. Similarly, the S&P 500 follows the 500 companies with the largest capitalization in the U.S. There are indexes that follow clean energy, small businesses, and even the entire market.
When you choose a stock index mutual fund, you get access to everything in the fund and you are likely to see performance similar to that of the index fund. If you choose an all-market fund, for example, you can expect to see gains and losses in line with the whole market.
Exchange-traded funds (ETFs) are traded like stocks on the exchange. They are a little different from mutual funds; you don’t actually own the investments in the ETF. However, the performance follows a chosen collection of stocks and you gain when the collection does.
Many beginners start with index mutual funds and ETFs because they spread the risk — you don’t have to worry about picking the “right” stock. Many robo-advisors use index ETFs to build portfolios.
Focus on the long-term when investing in stocks
The best way to increase your chance of success when investing in stocks is to focus on the long-term.
Stock prices go up and down. Market cycles and economic trends ensure that stocks as a whole sometimes have a losing year. However, over time the stock market in general trends upward.
Although there are periods of losses, you can see that the market moves upward, even when adjusted for inflation.
One way to build your nest egg is to invest in a stock index fund consistently. Put a set amount of money in the account each month for two or three decades. This is one of the best ways to grow your wealth — especially if you don’t have a lot to invest at first.
Even if all you do is open an account with a robo-advisor and invest just a few bucks every month, you’re likely to be ahead of the game. In the end, learning how to invest in stocks is a smart bet to secure your future.
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