How to Invest in Stocks

Are you thinking of investing in stocks for the first time, but not sure where to start?

Have you always wanted to invest in stocks, but have been put off by all the confusing jargon that you don’t understand?

In this article, we will guide you through the basics of what you need to know before you start, a variety of strategies and tips to help give you the best chance of succeeding, and the myths and mistakes to avoid. After you finish reading, you’ll know where to start, have a better idea of what to expect and how you’re going to invest, and stop thinking that investing in stocks is as scary and complicated as it may sound in the stories you’ve heard.

Now, let’s get started.

Article Overview

Part 1: Preparing to Invest in Stocks – What You Need to Know

Part 2: How to Invest in Stocks – Different Strategies

Part 3: How Not to Invest in Stocks – Common Myths and Mistakes to Avoid

Part 1: Preparing to Invest in Stocks – What You Need to Know

Before you start investing in stocks, it’s important to cover the basics to give you a better idea of what to expect and help you to make good, informed decisions.

Let’s start with the key terminology.

Key Stock Market Terms You Should Know

Of course we can’t include every term that you’ll need to know, but here are some to get you started, and we’ll explain more throughout this article.

  • Balance Sheet – The financial statement which shows the liabilities and assets of a company.
  • Bearer Stocks – This is the stock that is unregistered with the owner’s name.
  • Bid Price – This term indicates the sale price of stocks or shares.
  • Blue Chip – These are shares of big and reputed companies.
  • Book Value – The net worth of the company as listed on the balance sheet.
  • Bull – A person who considers the share prices in the stock market to be on the rise.
  • Capital Appreciation – The increase in the value of the company and consequently its share price.
  • Debenture – The stock that a company issues which are backed by assets.
  • Deflation – Deflation is a period of falling prices of goods and services in the economy. This is the opposite of inflation, which is when general prices rise over time.
  • Dividend – The part of the company’s profits which is usually distributed to company’s stock holders, normally on a regular basis.
  • Equities – These are the ordinary shares. They are different from debenture and also from loan stock.
  • Financial Ratio – Various ratios that indicate the health of a business and value in the stock.
  • Initial Public Offering – The issue of new shares by a previously private company as it becomes a public company.
  • Intrinsic Value – The actual value of a company or asset.
  • Limit Order – This is an order to any stockbroker specifying any fixed price limit.
  • Liquidation – Converting the prevailing assets to cash.
  • Loan Stock – The stock that bears a fixed interest rate. It’s different from debenture stock because it’s not required to be secured by any asset.
  • Portfolio – A selection of shares usually held by a person or fund.
  • Risk Tolerance – The degree of uncertainty in investment returns that an investor is willing to withstand.
  • Stock – Also referred to as share or equity, stock is the basic ownership unit of a company.
  • Time Horizon – The length of time between making an investment and selling it.
  • Value Stocks – Stocks that appear to be trading at a discount to their intrinsic worth, as measured by various different valuation metrics.
  • Yield – The gross dividend presented as the percentage of the share price.

If you find yourself struggling to understand a term and want to learn more, here are some comprehensive lists to help you learn useful terms:

Different Types of Stocks

Not only do you have to choose which stocks to invest in, but you also have to choose what type of stock. The two most common types of stocks are preferred stock and common stock.

Preferred stock owners are paid a fixed dividend and receive their payments before common stock owners, but they don’t have any voting rights within the company. Although preferred stock owners are given priority over common stock owners for dividend payments, common stock owners are given voting power.

There are also three different classes of common stock: class A, B, and C stock. Class A stocks are usually sold to the public, but are not as desirable as the others because they have limited voting rights. Class B stocks tend to have more voting rights, but are usually held by company management or founders. And class C stocks encourage the company management or the class B stock holders to run the company for their own benefit rather than for the benefit of the public stock holders.

Read our post What are Different Types of Stocks? for a more detailed look at the different types and classes of stocks.

7 Basic Questions to Ask Yourself

Before you decide how you’re going to invest in stocks, there are also a few basic questions that you should ask yourself first. This step is especially important, as it will help you to make better, more informed decision later, and help you to determine exactly how much risk you are willing to – and can afford to – take.

1. What are your investment goals? In other words, why do you want to invest in stocks? What are you planning to do with the money? For example, are you saving for a holiday, for college, for a house, or for retirement? Make sure to keep in mind your investment goals, because they will affect how you make decisions when investing in stocks.

2. How is your current financial situation? Before you start investing, make sure that your current financial situation is stable, so you can support yourself and your investments, and avoid finding yourself in trouble later. You should also make sure to set aside an emergency amount of money, such as an amount to last you for at least 6 months. Just think about how much you need to have to fall back on in case your investments don’t work out or you lose your job, because otherwise the added pressure could cause you to make bad, emotionally driven decisions.

3. What is your time horizon? As we mentioned earlier, your time horizon is the length of time between making an investment and selling it. Setting this time frame at the start will help you to determine how much risk you can afford to take. For example, if you’re saving for a short-term goal and need the money soon, such as for a holiday, you can’t afford to take too many risks.

4. How much money are you willing to invest? Don’t start investing in stocks without a clear idea of how much you are willing to invest, because you could end up in a lot of trouble that way. Make sure to know your limit.

5. How much investment experience do you have? Investment experience is another important factor in determining your risk tolerance. Are you a beginner? Or do you have years of experience in stock investing? If it’s your first time investing in stocks, then you may not want to take too many risks yet.

6. Do you want a financial planner? Decide whether or not you want a financial planner. You still need to find a stock broker, but if you don’t feel confident about investing on your own, then you may need to find a financial planner as well.

7. How high is your risk tolerance? Answering the previous questions will help you to determine what type of investor you are in terms of your risk tolerance: a conservative investor who rarely takes risks, a moderate investor who finds a balance, or an aggressive investor who is experienced enough to be able to take big risks.

How to Choose the Right Stock Broker

So you’re ready to find a stock broker?

If you have never opened a brokerage account before, choosing the right stock broker can be difficult because you may not know what to look for or even what to expect. To help make the process easier for you, here are some tips and things to consider to help you find out if a stock broker is the right one for you:

  • Full-service or discount broker – Decide whether you want a full-service broker or a discount broker (also known as an advisory or online broker), as this will help to narrow down your search. If you need help deciding which stocks to invest in, or want a stock broker who also offers financial planning services, then choosing a full-service broker may be better for you. But, if you have more experience and are confident in your stock market knowledge, then you may prefer a non-advisory broker.
  • Verify licenses – Contact the Washington Department of Financial Institutions Securities Division at 360-902-8760 to verify potential brokers’ licenses.
  • Broker-resellers – Broker-resellers are not usually considered as reputable as regular brokers, because not all broker-resellers have the necessary qualifications. So make sure to do your research and check your potential broker’s background before choosing them.
  • Minimum account balance – Find out if they require a minimum account balance to be able to open an account with them.
  • Fees – Look for the lowest fees, but make sure that the quality is still high. Keep in mind that full-service brokers charge higher fees because they offer more services and support.
  • Terms and conditions – Check their terms and conditions. It’s important to know if there are any specific requirements or other fees. For example, they may charge fees for inactivity, account maintenance, or not maintaining the minimum account balance.
  • Trading fees – These are the fees that they charge for every trade you make. Check how much they are before choosing a broker. Look for reasonable fees, but keep in mind that lower fees may not always be the better option because they usually mean that the service and support is not as high quality.
  • Broker-assisted trading fees – These are the fees that brokers charge if you want them to make your trades for you. Avoid these if you can because they are more expensive.
  • Withdrawal fees – Check if there are withdrawal fees. Some stock brokers will charge you if you withdraw from your account.
  • Margin account – With this type of account, you borrow money from the stock broker to buy stocks. Avoid this type of account if you’re a beginner.
  • Level of support – How much support is available? Would you prefer calling them for help, or being able to meet them in person? It’s important to find out how much support they offer, and what kind, especially if they’re an online stock broker.
  • Extra benefits – Look for stock brokers who offer extra benefits. You shouldn’t base your decision solely on this, but it’s worth looking out for.
  • Potential brokers – When you have a shortlist of potential brokers, make sure to discuss your investment goals with them before choosing one. Consider all of your options first.

Part 2: How to Invest in Stocks – Different Strategies

Now that you’re ready to start investing in stocks, let’s take a look at the different strategies for investing in stocks. We’ve also provided further reading material to help give you a more in-depth look at each strategy.

11 Strategies for Investing in Stocks

1. Value investing. Value investors buy stocks when they sell at a discount to the intrinsic value of the company. In other words, they buy undervalued stocks. This strategy was popularized by Benjamin Graham and David Dodd in their 1934 book Security Analysis.

Further reading:

2. Growth investing. Growth investors focus on the growth of their capital by investing in growth stocks, which are stocks in companies with the potential for above-average growth. This strategy is based on capital appreciation, rather than dividend income, so it can be quite risky.

Further reading:

3. Income investing. Income investors choose stocks from companies that have steady streams of income.

Further reading:

4. Momentum investing. Momentum investors focus on choosing stocks that have had high returns and are moving significantly in one direction.

Further reading:

5. GARP investing. GARP stands for Growth At A Reasonable Price. This strategy combines growth investing and value investing, as GARP investors choose stocks from companies that are undervalued but still have the potential for significant growth.

Further reading:

6. Fundamental investing. This strategy describes any process that involves investment decisions being made based on how well the company is doing. In other words, the idea that if the company does well, then the stock price will also do well.

Further reading:

7. Technical Analysis. Technical analysis, also known as behavioral investing, is based on psychological research and studies the supply and demand in stock markets.

Further reading:

Other General Strategies:

8. Choose your stocks wisely. In other words, avoid relying on speculation to choose your stocks. Speculation is when you make stock investment decisions on a whim or because many others are making the same decision. Don’t just think that because everyone else is doing it that you should do it as well.

9. Know when to sell. Of course choosing stocks wisely is important, but knowing when it’s the best time to sell them is also important. Check out our article When to Sell Stocks – 9 Different Situations for advice on when you should sell your stocks.

10. Learn deflation investment strategies – just in case. Check out our article How to Invest During Deflation for tips to help you understand how deflation can affect the stock market.

11. Find a mentor. Having a mentor who you can go to for help is especially great for new stock investors.

12. Learn from the best stock investors. Learn from successful investors such as Warren Buffett, Benjamin Graham, Peter Lynch, and Jeremy Siegel. Check out Part 3 of this article for recommendations for books that these investors have written.

Part 3: How Not to Invest in Stocks – Common Myths and Mistakes to Avoid

Knowing how not to invest in stocks is also important, especially for those who want to avoid common myths and mistakes that new stock investors tend to make. Here are some examples to help you avoid them:

5 Myths You Should Stop Believing

1. Investing in stocks is the same as gambling – This is one of the most common myths. Of course there is still risk involved, but, as you know from reading this article, investing in stocks is clearly not the same as gambling.

2. Only wealthy people can make money from stock investments – This is not true. You don’t need to have excessive amounts of wealth to be able to do well in the stock market. With the right stock broker and an effective investment strategy, you have just as much of a chance as wealthier investors do to become successful stock investors.

3. You can invest in stocks easily if you’ve already made other investments before – Just because you’ve made other investments before doesn’t mean that you know everything you need to know to invest in stocks. Make sure to do all of your research first, and consider hiring a financial planner to help if you don’t have the time or necessary knowledge to do it all on your own. Keep in mind that paying for a financial planner may be expensive, but it will cost you more if you start investing in stocks without having a solid understanding of how to do it.

4. Stocks that go up will eventually come back down – This is a myth because it doesn’t happen all the time. Sometimes stocks will stay up, and those who believe this myth may not have profited from it because they expected that it wouldn’t last.

5. You must always buy stocks when they’re low – Many investors, especially new ones, believe this myth. Keep in mind that even if you were to try to buy low and sell high, you still need to do your research so that you can make an informed decision based on more than just how low the cost is.

5 Mistakes to Avoid

1. Making emotionally-driven decisions – Don’t let emotions such as fear and greed influence your decisions when you invest in stocks. If you do, you will only increase your stress and be more likely to make poor decisions, so make sure to not exceed your risk tolerance. This is why determining your risk tolerance before you start investing is especially important, as it will help you to avoid this mistake.

2. Confusing cheap for being good value – Cheap doesn’t always mean better value. For example, a cheap stock broker has less fees, but they may not offer the high quality services and support that you may want.

3. Allowing herd mentality to influence your stock investment decisions – Don’t think that just because everyone else is doing it, you should as well. Herd mentality is quite common in stock investing decisions, so check out our article Herd Mentality: Are You Being Set Up to Fail to make sure that you’re not making this mistake.

4. Rushing into decisions – If you’re still doing research and are not completely ready to buy stocks, don’t buy them. Even if something changes and it seems like you will miss a big opportunity if you don’t buy them now, you should still wait. Rushing into a decision before you’re certain that it’s the right decision could cause you more trouble later.

5. Protecting your bad choices – Don’t let loss aversion make you want to protect your bad choices. It may seem obvious that once you make a bad choice, you should fix it, but loss aversion makes investors feel that avoiding more losses is preferable to acquiring gains.

New stock investors often make mistakes because they look in the wrong places for advice, and don’t make the most of all the resources and tools available to gain an advantage.

So, we’ve gathered a list of the best resources for new stock investors, including books by some of the most well-known and successful investors, as well as online resources, tools, and simulators to test your skills. Check them out below – you’re sure to find something useful.

Useful Resources

Books:

  • The Essays of Warren Buffett: Lessons For Corporate America by Warren Buffett
  • Buffett: The Making of an American Capitalist by Roger Lowenstein
  • The Intelligent Investor by Benjamin Graham
  • Beating the Street by Peter Lynch
  • Common Stocks and Uncommon Profits by Philip Fisher
  • Stocks for the Long Run by Jeremy Siegel
  • The Four Pillars of Investing by William Bernstein
  • How to Make Money in Stocks by William J O’Neil
  • Reminiscences of a Stock Operator by Edwin Lefèvre

Online resources:

Tools and simulators: