Looking to get into the stock market? Investing in stocks can be an exciting and lucrative way to boost your income. That said, venturing into the markets for the first time can also feel overwhelming in the beginning. Join us for an overview of stock market basics as we break down some of the most important things that beginning stock investors should know.
What is the Stock Market?
While there are many, much more complicated ways to answer this question, if you’re brand new to the stock market, then the odds are that a lot of them will sound like gibberish to you. So let’s break it down with a metaphor that everyone can understand.
Do you know how some people are into collecting? Whether it’s coins, stamps, or art, collectors often purchase various items with the hope that they’ll go up in value, usually due to supply or demand? The stock market operates on a similar premise.
Only instead of Pokémon cards or Picasso paintings, the stock market revolves around the trading of stocks, which are shares of ownership in publically traded companies. The stock market is where these shares, also sometimes known as “equities” are bought and sold. The two largest stock exchanges in the U.S. are the New York Stock Exchange (NYSE) and the Nasdaq.
How Does the Stock Market Work?
When a company meets certain qualifications, it can sell shares of its company on a stock exchange in order to raise money for its business. When these shares are listed on a major exchange, investors have the chance to purchase the shares through a broker.
A broker is a person or firm that works as a sort of intermediary between the buyers and sellers of equities. These days, you can either open a brokerage account at a physical brokerage or open one online with a commission-free brokerage such as TD Ameritrade, WeBull, Charles Schwab, Robinhood, etc.
When you use one of the online brokerages above, you’ll create an account that will show you all of the stocks available to buy, sell, and trade on the major stock exchanges. You can then fund your brokerage account by linking it to your bank account. You’ll then be able to purchase shares in the companies you are interested in without any additional fees, right from your phone or computer
Bull vs Bear Markets
So why do people buy shares in companies in the first place? This is where the magic of the stock market comes into play. Due to supply and demand, the value of each share in a company that does well tends to go up. When you’re “bullish” on a stock, that means that you think that a company’s shares will be worth more in the future.
If, for instance, you know that company ABC is about to release a hot new product, you might buy a share of its stock for $25. The hope is that when the product is released, investors will flock to company ABC’s stock shares like Beanie Baby collectors in the early ’90s. When this happens, your share may go up in value to, say, $50. If you choose, you can then sell it for a nice profit.
If you’re “bearish” on a stock, that means you think that a company’s stock is headed for trouble and will decrease in value. Sometimes, the entire stock market can follow one of these two trends, based on factors such as major news or international crises. When the COVID-19 pandemic broke out, stocks across the board took a nosedive, resulting in what’s known as a “bear market.” But when the economy began to reopen, slowly but surely a new “bull market” began, as most stocks began to rise in value again.
Market Crash vs Market Correction
As the old saying goes, what comes up, must come down. It’s no different with stocks, as no stock has ever managed to only go up in value without experiencing some downward drops along the way.
These downward dips are normal, but two types tend to stand out based on how severe the dip is and how long it takes to occur. A stock market correction is a moderate decline of anywhere from 10% – 20% in the value of either an individual stock or an entire market index as a whole from a recent peak. Market corrections tend to be gradual and can happen over the course of days, weeks, or even months.
A market crash, however, is a bit more serious because it happens very quickly. During a market crash, the value of a stock or the overall market suddenly plunges within a day or week. Back in 1987, for instance, the market “crashed” when a huge array of stocks suddenly dropped 23% in value in a single day.
What Is Diversification?
You know how they say never to put all your eggs in one basket? That’s basically the premise of diversification. Say, for instance, that you’ve got $5000 in your brokerage account. If you buy $5000 worth of stock in Company 123, you better be really sure it’s on the path to success.
After all, the market is a fickle beast, so you always run the risk of its value, and therefore the value of your entire portfolio, dropping.
Diversification means investing in several different companies. In this instance, rather than investing your full $5000 in one company, you might invest $1000 in five different companies. That way, even if one goes down in value, hopefully at least one or more of the other will go up and balance out the loss.
Risks and Benefits of Investing in Stocks
The stock market can be a great way to invest your money for long or even short-term gains. Just realize that there are always risks involved, no matter what company you invest in. The best way to up your odds of success is through educating yourself on how the stock market works and developing your own unique trading style.
While some people equate the stock market to gambling, that isn’t really the full picture. Imagine, for instance, that two people sat down to play a game of poker against each other in Las Vegas. If one is a professional poker player and the other has never played a full game of cards in their life, it’s not going to be much of a surprise when the professional wins. The same concept holds true in the market. If you’re well educated, your odds of success are substantially higher than someone who hopes for the best but has no idea how to read a chart.
If you’re still unsure of what makes for a good investment, try starting with a trading simulator which will allow you to practice trading without using real money. This is a great way to learn how to maximize the benefits of investing in stocks once you get your bearings, all while using a risk-free short-term learning strategy.