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How To Invest In Stocks For Beginners
How To Invest In Stocks For Beginners

How To Invest In Stocks For Beginners

The stock market is one of the most reliable and accessible ways to create wealth. Thanks to technology, you can now begin your investing journey with as little as $100 – and you can begin learning about the market for free. In this guide we explain what the stock market is, how it operates and how you can get started investing or trading.

Stock Market Definition

A stock market is any collection of exchanges where the shares of publicly listed companies are traded. The global stock market includes all listed stocks and the exchanges they trade on. A country’s stock market would include all exchanges based in the country and the stocks listed on those exchanges.

In some cases, OTC (over the counter) marketplaces may also be considered part of the stock market. OTC markets are marketplaces where unlisted securities are traded.

What is the purpose of the stock market?

Stock markets and stock exchanges exist to give companies access to capital, and to allow investors to find investments that allow them to see positive results on their trading.

Companies and the Economy

For an economy to grow, new companies need to be started and existing companies need to grow. A stock exchange is a regulated marketplace for companies to access capital from investors looking to earn a return on their capital.

From a company’s perspective, an exchange aggregates investor capital which ensures that large companies can access the capital they need.

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Investors

For investors, a stock exchange, and the stock market in general, is a marketplace for investment opportunities. A stock market provides a platform for investors to buy and sell shares in companies and to access information on those companies. Stock exchanges regulate the trading of stocks, ensure that information is made available to investors and ensure that companies comply with certain requirements.

From the investors perspective a stock exchange aggregates companies in one place.

Traders and Brokers

Stockbrokers act as an intermediary between investors and the exchange. They make sure orders are entered and trades are settled according to the exchange’s rules and guidelines.

Brokers and active traders also provided liquidity to a market. This allows investors to easily buy and sell shares when they needs to. Greater liquidity attracts more investors, which lowers the costs of capital for companies. Traders can benefit from short term price movements in stocks whilst also contributing to the efficiency of a market.

How Does the Stock Market Work?

The stock market’s role can be broken down into two parts: the listing process and trading operations.

Listing

To be listed on a stock exchange companies must comply with a number of requirements. Some of these requirements depend on legislation in the country they want to be listed, while others are specific to each exchange. Typically, companies must provide audited financial statements for a certain number of years and have a minimum amount of paid in share capital. In many cases the company’s market value and liquidity will need to meet a minimum threshold.

An OTC market has less onerous listing requirements. Typically, the stocks traded on OTC markets belong to smaller companies and those that don’t meet the requirements of exchanges. OTC stocks are therefore often riskier than publicly listed stocks.

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Trading Operations

A stock market operates as a continuous auction during which buyers and sellers can enter orders. When buy and sell orders match, a trade occurs. After a trade takes place, cash and shares change hands during a settlement period.

Nowadays nearly all trading is electronic. Exchanges are responsible for making systems available to manage and match orders ,and to settle trades. Orders can only be entered into the system by brokers that are member of the exchange.

Exchanges manage the market with a set of rules that govern issues like trading times and the types of orders that can be entered.

What is a Stock Market Index?

A stock market index is an indicator that reflects the price performance of a collection of shares. The index is a weighted average of the prices of stocks in the index. Most indexes are weighted by the market value of the companies it includes, so larger companies have more influence on the index value.

Indexes can include all the stocks in the market or include companies by size or sector. Headline indexes like the S&P 500, FTSE 100 or Nikkei 225 typically include the largest companies in a given market and typically account for around 85% of the value of listed companies in a market.

Stock Market Instrument Types

Stocks are the primary trading instrument in a stock market. However, as markets have evolved, other instruments related to stocks have emerged. However, all other stock market instruments are based on the prices of stocks.

Stocks

The terms stocks, shares, and equities can be used interchangeably, and all refer to an equal unit of ownership in a company. Most shares are common shares which entitle their owner to one vote per share and the right to an equal share of any dividends paid. If the company is liquidated, each common share gives its holder an equal claim on remaining assets after creditors are paid.

Non-voting shares are the same as common shares but carry no voting rights. Preference shares are shares that pay fixed dividends and give their holders a preferential claim on assets in the case of liquidation. Preference shares are similar to bonds, but trade on a stock market.

Exchange Traded Funds (ETFs)

ETFs are baskets of shares that are listed on exchanges and trade just like listed companies. ETFs track popular stock indexes like the S&P 500 as well as custom indexes that give investors exposure to specific sectors, industries, and investment themes. Exchange traded funds allow investors to own lots of stocks with just one investment.

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Mutual Funds

Mutual funds are similar to ETFs in that they are investment funds that contain multiple stocks. They differ in three respects though. Firstly, they are actively managed by a fund manager and do not track an index. They are not traded like other instruments – rather, capital is invested in the fund based on the value of the fund each day. Mutual funds are more expensive to own due to the fact that they are actively managed.

Futures

Futures are exchange traded derivatives. They are agreements to buy or sell an underlying asset at an agreed upon price but at a future date. Stock related futures contracts are traded on individual stocks and on stock indexes.

Futures contracts offer two significant advantages. They are margined which means the full value of the contract is not required to trade them. They also make the process of short selling easier than it is for stocks.

Futures on stocks and stock indexes typically trade on separate derivative exchanges.

Contracts for Difference (CFDs)

CFDs are similar to futures contracts but are not traded on exchanges and have no expiry date. They are agreements between traders and brokers or banks and are rolled from one day to the next.

CFDs can be traded on stocks and stock indexes, as well as other asset classes. They also offer leverage and simplicity when short selling. CFDs are ideal for independent traders who require leverage and the ability to short sell.

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How to invest in the stock market

Type of investing

Description

Pros

Cons

Value investing

Value investors buy stocks they believe are undervalued.

  • Value stocks offer a margin of safety due to the fact that the stocks are already trading on a low valuation.
  • Value investing requires a lot of patience.
  • Good accounting and analysis skills are needed.

Growth investing

Growth investors buy stocks that they believe will grow their potential profits quickly over time.

  • Growth investors get to profit from the fastest growing sectors of the economy.
  • Growth stocks usually trade at a premium, and their prices decline substantially when growth slows.

Income investing

Income investors focus on stocks with high or growing dividend yields to generate cash flow.

  • A portfolio of dividend stocks can eventually generate enough income to make an investor financially independent.
  • Dividend stocks are usually quite mature and grow very slowly. Dividend investing is a long-term strategy and requires patience.

Trading – speculating with derivatives

Traders have shorter timeframes and focus on supply and demand to profit from rising and falling prices.

  • Traders can profit in rising and falling markets.
  • Returns can be improved by using leverage.
  • The use of leverage can also magnify losses.
  • Traders need to follow the market more closely and invest more time in the market.

What to choose?

Over the last decade, growth investing and trading have become more popular approaches in the stock market. Value stocks and dividend stocks have underperformed growth stocks because the technology sector has come to dominate the economy.

Trading platforms like Libertex with advanced tools and instruments like CFDs have made trading accessible to more people.

How to choose stocks to buy, and what to look for before you buy a stock

There are tens of thousands of listed companies around the world. An investors job is to narrow that down to between 10 and 60 stocks they expect to perform well over a number of years. Traders have shorter time horizons and look for stocks that they expect to move up or down over a period of days, weeks or months.

A stock screener is a tool you can use to find stocks that conform to specific criteria. For companies listed on US exchanges the FinViz screener is a good choice. For global stocks you can try the MarketInOut screener, or you can find more detailed data on the Reuters website.

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Growth

The value of a stock increases as the company’s earnings grow. Over the long-term, earnings growth and revenue growth are essential for the valuation to increase. In reality a stock’s price movements depend on how earnings growth compares to expected earnings growth. The price at any given time reflects the market’s expectations for future growth. If growth is lower than expected, or expectations fall, the share price should decline. If growth is better than expected, or if expectation rise, the share price should rise.

Revenue growth and earnings growth are both important, and these should be compared to previous periods, and to a company’s competitors.

Value

The other important factor is the valuation of a stock when you buy it. If a stock is fairly valued its stock price can be expected to increase along with its earnings growth. If the valuation is low, earnings may not need to grow for the stock price to increase – however, a low valuation may also indicate that there are problems with the company. If the stock is expensive, earnings will need to grow rapidly for the price to continue rising.

The common valuation metrics to consider are the P/E (price to earnings ratio) and P/S (price to sales ratio). These can be compared to similar companies in the same sector and to the market as a whole to get an idea of the relative valuation of a company.

Margins

There are two ways for companies to grow their earnings. Either they must grow their revenue, or the must increase their profit margins.

Margins vary widely from one industry to the next, but what really matters is whether margins are increasing or decreasing.

You can compare a company’s gross margin, operating margin and profit margin to its competitors, and to previous years to get an idea of how well it is performing.

Size and Liquidity

Larger companies tend to be less risky. Companies with a market value above $2 billion are usually more stable. Those with a market value between $500 million and $2 billion are still worth considering but require more analysis. Stocks with average trading volume above 200,000 will also offer more liquidity and can be exited quickly.

Balance Sheet Strength

Companies with too much debt can run into trouble easily. Generally, a debt to equity ratio below 0.5 is considered safe. Debt levels do vary from one industry to the next, so you should also look at the debt levels of similar companies.

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How to trade on the stock market?

A step by step guide to investing in stocks for beginners. Whether you are trading or investing, you can follow the following steps to get started.

Step 1 – Open a trading account

The first step is to open a trading account. Even if you open a demo account without committing any money, this will allow you to create a watchlist and begin tracking the stocks that interest you.

Step 2 – Decide on a strategy

You may decide to trade actively or invest for the long term. Either way, you should develop a process and rules to follow to select stocks and make trading decisions. This will help you to prevent emotions influencing your decisions. Your strategy should also determine the amount you risk on each trade and a risk management strategy.

Step 3 – Create a watchlist

Once you have a strategy and process you should begin to build a watchlist of stocks you are interested in. This will help you to focus on the stocks that fit into your strategy and you can ignore all the other noise in the market.

Step 4– Monitor the stocks on your watchlist

By closely tracking the stocks on your watchlist and how they respond to news events and market trends, you will get an idea of what affects them most. This will help you decide what will trigger a decision to trade.

Step 5– Enter trades when the time is right

When you have monitored a stock for some time you will get an idea of the price that may offer you an opportunity according to your strategy. This is when patience is required, and you will need to wait for the price to reach your level. When the price gets close to your level, you can enter a limit order to open a position.

Step 6– Monitor positions closely

Once you have an open position you will need to monitor it closely.

At this stage you should stick to your strategy and only exit when the price reaches your target price, or if your risk management levels are breached.

Strategies for stock market trading - how to play the stock market actively

The following are four of the most popular strategies for trading the stock market.

Momentum Trading

When the price of a stock or index is in a clear trend, trades can be entered in the direction of the trend after a retracement or a period of consolidation. The objective is to hold a position while the price continues moving and then exit when momentum slows.

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Range Trading

Stock prices frequently consolidate in a tight range for weeks or months at a time. This gives traders the opportunity to buy at the bottom of the range and sell, or open a short position, at the top of the range. If the price breaks out of the range positions should be exited quickly.

Breakout Trading

If the price of a stock breaks out of a trading range it will often move quite quickly as the momentum attracts new traders. Like momentum trading, potential profits should be taken as soon as momentum slows, and losing trades should be exited quickly.

News Trading

News traders track the news flow around a handful of stocks and base their trading decisions around changing narratives. Typically, a stock price will move immediately after news is released and then again a day or two later. This give traders who understand specific companies well a few chances to trade a stock after each news release.

What is the best way to learn about the stock market?

Whether you are an investor or a trader, the best way to learn about the market is by opening a trading account so that you can create a watchlist and begin tracking the market. The first step is to find a good broker that suits your needs.

When choosing a broker, it’s important to consider the following:

  • Does the broker offer all the instruments you want to trade?
  • Is the broker properly regulated?
  • Are their commissions and spreads competitive? Cheaper isn’t always better, but the fees you pay should be competitive.
  • What are their platforms like? They should be able to offer you a free demo account, and this will allow you to test the platform.
  • What is the minimum amount required to open an account and what is the minimum trade size? Obviously, this should suit your budget.

Conclusion

The stock market is the most accessible way for most people to create wealth and grow their savings. Trading and investing are skills you can develop over a time and may ultimately allow you to become financially independent.

Trading is the quickest way to learn about the stock market. Even if you eventually become a long-term investor, active trading will give you more practice and allow you to find your niche in the market. And, it costs nothing to get started. You can open a free demo trading account with Libertex or you can open a live trading account with as little as $100. This will allow you to begin your trading journey immediately.

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FAQ

How do I begin to invest in the stock market?

The best way to get started is to open a trading account and begin learning about the stocks of companies that interest you.

Is trading risky?

Yes, it can be risky, but you can manage the amount you risk.

How much should you invest in stocks when you start?

It’s best to start with a small amount and increase it as you build confidence and develop a process.

Is it a good time to invest in the stock market?

It’s always a good time to get started with investing. It’s very difficult to predict the best time to invest in the market, but if you have a long-term time horizon that shouldn’t matter.

Where do I buy stocks?

You will need a trading account to buy stocks. You can open a stock trading account, or a CFD trading account with a global broker to trade stocks.

What are the best stocks to buy for beginners?

When starting out you should consider the stock of companies you know and understand.

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