Everything beginners need to know about investing in the stock market can be found right here, and learned in little to no time. Before you know it, you’ll be a savvy enough investor to start walking and talking like you work on Wall Street!
Consider this your ultimate guide to investing. In it we will discuss the following:
- Investing for beginners: Learn the basics of investing including what a share of stock is, how the stock market works, the difference between public and private companies, and what a stock exchange is.
- Investment strategy beginners: Investors can approach investing with different strategies based on your comfort, desire and belief. We’ll cover some common investing strategies and how they work.
- Options for beginners: Learn how an options contract works, the difference between a “put” and a “call” option, and what the strike price is for options contracts.
- Technical analysis vs. fundamental analysis: We’ll discuss the difference between each of these approaches to analyzing investments and discuss when and how to use technical and fundamental analysis when investing in the stock market.
By the end of this guide, you’ll no doubt be ready and confident that investing is a game anyone can play, and one that everyone should be involved in to build wealth and grow the economy.
The birth of the stock market
Investing has been around much longer than you might think. In fact, the first stock exchange was created in 1792 on Wall Street in New York City, NY. It was called the “New York Stock & Exchange Board” and later changed its name to the New York Stock Exchange (NYSE) which is what it’s known as today.
Back then, it was a trade that was practiced by businessmen and wealthy people who could afford to invest in the stock market and understood it too. Thankfully, with modern technology and near immediate access to stock market exchanges, anyone with as much as even $5 can invest in the stock market.
The problem is, most people get a bit intimidated to ever start investing due to all the fancy jargon, price charts, mathematics and ratios. They think it’s a trade only practiced by “businessmen and wealthy people” as it once was. The truth is, you don’t have to be an expert to invest in the stock market, and it doesn’t take all that much understanding to get started.
Investing in the stock market for beginners
An investment is a financial transaction or purchase in which you allocate your money to with the expectations of getting more money back than you started with. For example, you might purchase a home for $300,000 today with the expectations that its value will be worth $350,000 in the near future.
Investments can be in anything such as stocks, commodities, currencies, bonds, real estate, cryptocurrencies, and loans. You can even say that spending money on your college degree is an investment, in that you will make back a lot more money in the future from the knowledge you gained in earning your degree!
What is a share of stock?
A share of stock is an intangible asset whose value lies in the percentage of ownership of a stated company. If one owns a share of stock, in essence, they own a small piece of the said company. The monetary value of a share of stock equals the dollar amount that a potential buyer is willing to pay you in exchange for the stock share’s contract of company ownership.
How the stock market works
You and your friend decide to open up a retail clothing store locally. You figure it takes about $50,000 to start. You only have $25,000 yourself which leaves you short $25,000 to get started. You decide to reach out to your friend who is an avid investor. You tell him if he lends you $25,000 for your retail store, he will get 40% ownership of the company as a passive investor (meaning he isn’t actively involved in the operation of the company).
After the first year in business, you generated a total of $100,000 in profit (money left over after all business expenses). This profit is divided up between you, the business owner, and your friend, the passive investor who has 40% ownership in the company. His 40% ownership gives him $40,000 ($100,000 x 0.4 = $40,000) leaving you with $60,000. You both got back your original investment of $25,000 plus some.
This is exactly how the stock market works, but on a much larger scale where hundreds of millions of investors and businesses are involved. When you purchase a share of stock in any company, you expect the value of your invested capital to increase over time.
Private companies vs. public companies
A private company is any company that is not publicly listed on a major stock exchange. A company is privately owned until it’s grown to a size and valuation large enough to list shares of stock to the general public.
Once a company reaches large enough growth and overall valuation, it can decide to list its company stock on a major stock exchange. With the help of accountants, lawyers, and banks, they evaluate the company’s total size and monetary value and then determine how much of the company they wish to make available for purchase to the general public. Once completed, a company may wish to list 10,000,000 shares (for example) at $50 per share available to the general public through what’s called an Initial Public Offering, or IPO.
Once all of the shares listed through the IPO are sold, they are then traded (bought and sold) among individuals and businesses on a public stock market exchange (hence the name “exchange”).
What is a stock exchange?
A stock market exchange is a marketplace where businesses and individuals buy and sell stocks. A stock is a unit of ownership in a company. Its value is based on how much money that company generates, as well as what investors believe the company will be worth in the future.
Just like Amazon is a marketplace where you and I can purchase needed products and services, a stock market exchange is a marketplace where you can purchase shares of stock in any publicly traded company. The three major US stock market exchanges are the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotation System (NASDAQ), and the American Stock Exchange (AMEX).
How is the price of a share of stock determined?
After a company has issued it’s Initial Public Offering (IPO), it is then traded among individuals and businesses on a major stock exchange. But what determines a stock price, and why does this price fluctuate?
The answer to this question is dependent on many variables and could be a very complex discussion. Perhaps the easiest way to explain how a stock price is determined is to compare it to an auction. You may be familiar with how an auction works, with lots of new and used products available to an audience for purchase and goes to the highest bidder.
Imagine a painting being auctioned off, starting at just $100. There is an audience of 1,000 people and the painting ends up being sold to a member of the audience at $800. What do you think the winning bid price of that painting would have been if there were only 10 people in the audience? Would it have sold at a higher price or a lower price?
If you guessed that it would sell at a lower price, you got it right! Fewer people equals a lower demand, which equals less competition and ultimately a lower selling price. The same applies to the exact opposite scenario. More people in the audience would equal a higher winning bid due to the increased demand and buyer competition.
How does this apply to the stock market? A popular company with strong financials, clear vision for the company’s future, and great leaders will attract a larger audience and thus a higher winning bid price for a share of that company’s stock. A company who reports a loss of income from fallen sales last quarter will likely see a decrease in interested buyers, resulting in a lower price that people are willing to pay for a share of that company’s stock.
Long story short, the stock market is like one gigantic auction where stock shares are auctioned off by each investor and sold to the highest bidder.
Investment strategy for beginners
Deciding which companies to invest in can be approached in many different ways. The ultimate goal is to make more money and lose less money (or lose no money if possible). Here are some basic investment strategies that will eliminate common mistakes and accelerate your portfolio growth.
Buy & hold strategy
A strategy that long-term investors follow is simply buying stock in a researched company, and holding onto that stock for a long time, usually 10+ years. It’s been proven that investing in well-researched companies for the long run has a better than average return on investment, and eliminates the mistakes made from trying to “time” the market to “buy low and sell high.”
For example, if you had bought 10 shares of Amazon’s stock when it first went public in 1997, you would have paid $18 per share and a total of $180. Amazon’s approximate share price as of this writing is about $1,900 per share which would put your total investment value today at $19,000 (10 shares x $1,900 per share = $19,000).
Dollar cost averaging
Dollar cost averaging is an investment strategy in which you buy shares of stock on a regular periodic basis regardless of the stock price. An example would be an individual who sets up an automatic investment every month of $500 into their portfolio regardless of what the current prices are.
If your investment is going into a vehicle that is priced around $100 per share, you might purchase enter at $90 per share, $115 per share, $99 per share, etc. each time an investment is made. The average price point of all the investments made over time ends up being a lower price overall as compared to trying to time the market and only buy when you think the price is cheap.
This is a strategy that investors follow who seek to find companies whose real intrinsic value is actually higher than what the current stock price is at. In other words, they seek investments in companies that they believe are currently undervalued in the stock price with expectations that the price will correct in the near future.
Diversifying your investments means investing in multiple companies, and not just one. To take it even further, it also means investing in multiple market sectors, industries, investment vehicles, and even different asset classes.
By allocating your funds among multiple investments, you eliminate the risk of losing all your money to one failing company. If you’re properly diversified, one investment may be performing bad but another is performing very well, and the net result is still an increase. Diversification is an investment strategy that must not be overlooked.
A stock option is a contract or agreement between two parties to buy or sell stock at a stated price detailed in the contract. The buyer of an options contract is buying the right, but not the obligation, to buy or sell a company’s stock at the stated price in the agreement.
There are two types of options contracts; “call” options and “put” options, both of which we will discuss further below. Options contracts are not to be confused with owning shares of stock, but rather they are a contract to buy or sell shares of stock at a stated price in the future.
An options contract will detail the underlying stock company, the price at which the contract buyer may buy or sell the underlying security (called the Strike Price), and the expiration date of the contract. Options contracts give rights to buy or sell the underlying security generally in amounts of 100 shares. Since the contract is not actual ownership in a stock, the price of the contract generally costs a fraction of what 100 shares of the underlying security would actually cost.
Call options vs. put options
When an investor purchases a call option, they are buying a contract that gives them the right, but not the obligation, to buy 100 shares of stock at a pre-determined price. When might an investor buy a call option contract? If I thought the stock price of “ABC Company” is going to increase from $100 per share to $120 per share, I might buy a call option contract that gives me the right to buy the stock at $105 when the price of that stock reaches $120 per share.
When an investor purchases a put option, they are buying a contract that gives them the right, but not the obligation, to sell 100 shares of stock at a pre-determined price. When might an investor buy a put option contract? If I thought the stock price of “XYZ Company” is going to decline from $100 per share to $80 per share, I might buy a put option contract that gives me the right to sell the stock at $100 when the price of that stock drops to $80 per share.
Options contracts are often used as ways to hedge against loss. If I purchase 100 shares of ABC Company at $50 per share or $5,000 total, my hopes are that the stock price increases. However, I could be wrong and the stock drops to $40 per share instead, resulting in a loss $1,000 (Decrease of $10 per share x 100 shares = $1,000).
To substantially lower my risk of loss, I could purchase a put option contract that gives me the right to sell my 100 shares of ABC Company at $50 per share if the stock price drops below $45. That way, if ABC company drops in price to $40 per share, I can still sell my 100 shares at the same price I bought it at which was $50, lowering my total risk of loss to be equal to just the cost of the options contract.
Technical vs. fundamental analysis
Investors often use two types of approaches to investing in a company. Technical analysis and fundamental analysis.
Technical analysis is basing your buying or selling decisions based on the chart patterns and market behavior of the company. Statistically, the stock market tends to follow certain charted patterns and react accordingly, allowing investors to strategically buy or sell a stock when such statistics and price chart patterns indicate to do so. Most technical analysis investments are generally shorter-term investment decisions.
Fundamental analysis, on the other hand, refers to analyzing the financial statements, balance sheets, earnings, profit and loss ratios, and future plans of a company. Investment decisions are dependent on the strength of a company’s fundamental makeup and are generally longer-term investment decisions.
Four things when to remember when investing in the stock market
Regardless of your experience level with investing, no matter how you look at it there are certain truths that have stood the test of time that lead to successful investing in the stock market. They are:
- Invest regularly
- Invest early
- Diversify your total investment portfolio
- Invest in companies you believe in and understand
Combine those timeless truths to the investment strategies you’ve learned from this guide, and no doubt your future will be full of steady and healthy investment returns.