How to invest in the stock market & basic stock market terms explained

Have you ever thought about investing in the stock market? Many people consider investing in the stock market to be an excellent option for growing their wealth, but there are also those who think it is too risky and complicated. Which group are you in?

In this article, we are going to tell you everything you need to know to invest in the stock market safely and effectively. From how to start investing, to what financial products exist, types of orders, and investment strategies. Let’s get started!

Considerations before starting to invest in the stock market

Before making your first investment, you must take into account the following points:

• Invest only with money you can afford to lose: You should only invest capital that you do not need in the short term, that is, money that you have saved and that you can invest without compromising your current financial situation.

• Make an emergency fund: before you start investing, you should first create an emergency fund that will cover 6-12 months of your living expenses. This way, you won’t be tempted to sell your assets if anything goes wrong.

• Focus on the long term: It is important to keep in mind that the stock market is a volatile market, so it is essential to invest in the long term and be patient. Through a long-term investment strategy, you can get better returns and minimise risks.

• Look for well-regulated brokers: Choosing a well-regulated stock broker is essential when investing in the stock market. This means that the broker must be registered with and regulated by a recognised financial supervisor, such as the FCA in the UK.

• Diversify your risk: The more different assets you add to your portfolio (such as stocks, bonds, currencies, and funds), the lower your risk. You can also diversify across industries, economies, world regions, and more.

How to start investing in the stock market?

Well, now you know everything you need to know before investing, but how can you do it? Here are the guidelines you should keep in mind about how to invest in the stock market

1. How much money are you going to invest?: You must know the amount you are willing to risk to set up an appropriate strategy. This will help you determine the size of each position (i.e., how much you can invest in each asset).
2. Choose the broker that best suits your investor profile: There are many brokers on the market, but they are specialized in different niches. For instance, a CFD broker may not be suitable for you, you may want to opt for a broker that allows you to buy and hold real assets, not derivatives.
3. Open an account with your broker: To be able to start investing in the stock market, it is essential that you open an account with the broker that best suits your needs.
4. Deposit funds into your broker account: Once you create an account, you can first test your strategy in the demo account (if the broker offers one), then deposit your capital.
5. Place your order: Once you deposit real cash, simply open a position during the stock exchange hours to get started.

What are the main types of financial products on the stock market?

Once you have your account, the next step is to decide which financial products you want to buy. In the stock market, you can buy different types of assets, but the most common are stocks, ETFs, and derivatives.

Stocks

The stocks represent a part of ownership of a company. When you buy a stock, you become a shareholder and you have the right to receive a part of the company’s profits distributed as dividends. However, not all companies choose to distribute dividends; have a look at this beginner’s guide to dividends to get started.

To invest in real stocks, the broker you choose must offer them. Some brokers nowadays offer fractional shares – for instance, you can invest as little as $10 in any stock with eToro, which is a great strategy to create a diversified portfolio on a tight budget. Have a look at this eToro review to find out what this broker offers.

ETFs

ETFs (Exchange Traded Funds) are investment funds that are traded on the stock exchange. When you buy an ETF, you are investing in a basket of assets, which comes with many benefits, such as instant diversification and affordability. Have a look at how to choose an ETF, our list of best ETFs right now, and the best ETF brokers to get started.

Derivatives

Finally, derivatives are financial instruments whose value is derived from the value of another underlying asset, such as a stock or an index. These financial products have a high level of complexity and risk, so it is recommended that only experienced people in the market invest in them.

Also, derivatives are not very common when investing in the long term, but they are often used by savvy investors for hedging purposes.

Precisely for this reason, there is a wide variety of financial derivatives, such as:

• CFD trading (contracts for differences)
• Futures trading
• Options trading

Types of orders to invest in the stock market

Placing an order or exiting your position may sound straightforward. In fact, brokers allow you to execute different types of orders. These are useful when crafting your risk management strategy, which is a key component of your overall investment strategy.

Here are some examples:

• Market order – this is the simple type of order, which is executed when you send the order (if the market is open)
• Limit orders – this allows you to add the desired price at which you want to buy or sell, and the order is only executed when/if the price reaches that specific point
• Stop-loss order – this is one of the most important order types for risk management. Essentially, you set a minimum price limit for your assets, and if the price drops, the assets are sold automatically.
• Take profit – this type of order allows you to set a specific profit for your trade, and when/if it is reached, the position is closed automatically.

Find out more about stock order types.

Stock market basics: company events & terms

As time passes and you gain experience in the world of investment, you can face the following situations, which can affect your investment.

Stock splits

A stock split is a division of the value of a company’s shares. Companies use this technique to make shares cheaper, hence more attractive for new investors.

For example, let’s assume that the shares of a company cost £1,000 each. This amount may be quite high for new, smaller investors, so the company decides to perform a stock split 1:2. This means that each share will now cost £500 and there will be a double amount of shares in circulation.

So, if you were a shareholder before the split and your owned 2 shares, after the stock split, you would own 4 shares – the value of your investment remains the same, as 2 shares before (1 share for £1,000) are worth the same as 4 shares after the stock split (1 share for £500).

Reverse stock split

The reverse stock split is the opposite of a stock split. In other words, the company decides to “consolidate” its shares. In some cases, a very low share price may get the company delisted from the stock exchange, or there may be other reasons for the reserve stock split.

So, for instance, if you own 10 shares in a company and each share is worth £5, your total investment is £50. The company decides on a reserve stock split of 5:1, so you will now own 2 shares only for your £50 investment and each share is now £25 instead of £5.

Just like with the stock split, the reverse stock split doesn’t affect the value of your investment, but only the number of shares you have in your portfolio.

OPA (Public Offer of Acquisition)

A public offer of acquisition (OPA) is an operation by which one or more entities offer to buy some or all company’s public shares. It is also known as a takeover bid and may affect your investment in any direction, depending on whether the company you invested in is the want that offers to acquire another company or is the acquired one.

IPO (Initial Public Offering)

IPO stands for “Initial Public Offering” and is the event of listing the company’s shares on the stock exchange. After this moment, its shares will be available for buying, selling, or trading.

Delisting

It refers to the act of withdrawing the shares of a company from the stock exchanges, thus eliminating the possibility of trading. Carried out by the market supervisors, it has many causes, such as the company no longer being qualified for public listing (i.e., it no longer meets the exchange’s requirements), the company is being acquired, or many other reasons. One example is Twitter, which was delisted from the stock exchange after the acquisition.

Share buyback

Share buyback is an operation that consists of a company acquiring its own shares that are in circulation in the market. This is done in order to reduce the number of shares available in the market, increase the value of the remaining shares and improve the earnings per share.

In general, a share buyback is a positive sign.

5 stock investment strategies

Next, here are some of the most popular stock investment strategies:

Dogs of the Dow

The Dogs of Dow strategy was created by Michael O’Higgins and is well described in his work “Beating the Dow”.

It was conceived mainly to be applied to the Dow Jones Industrial Average (DJIA) stocks, but investors can use this strategy with any other index. Essentially, this strategy consists of:

• Picking the 10 companies listed on the stock index that have the highest dividend yield at the end of the last session of the year.
• Buy shares of those 10 companies.
• Keep those shares without selling all year.

Have a look at the Dow Jones stocks with the best dividends and this quick guide to global stock indices to get started with this strategy.

CANSLIM

The CANSLIM method for selecting winning stocks. It is an asset selection strategy designed by William J. O’Neil, founder of the publication Investor’s Business Daily and author of the book “How to Make Money in Stocks: A Winning System in Good Times or Bad”.

It is one of the most popular strategies for selecting stocks with explosive potential.. It is a more complex strategy that requires investors to do fundamental analysis. The right stocks must have a few characteristics:

• C – current quarterly EPS (earnings per share) increased massively (at least 20%) from the same quarter last year.
• A – annual EPS growth of at least 20% in the last five years.
• N – new products and positive events that push the prices higher.
• S – scarce supply (such as buybacks)
• L – laggard stocks within the same industry (usually RSI indicator is used to identify oversold companies)
• I – Institutional sponsorship of the company by a few institutions only.
• M – market direction by having a look at market averages. The company should be an over-performer in a bull market.

Dollar-cost averaging

Dollar-cost averaging (DCA) is a popular investment strategy that consists of dividing the total amount to be invested into exactly equal parts and then investing those amounts periodically, regardless of the price of the investment.

The term was first mentioned by Benjamin Graham in his book The Intelligent Investor.

This strategy is designed to reduce the impact of market volatility on your portfolio and maximise your long-term returns at a lower average cost for your shares. The idea behind it is to reduce the risk of buying at a time when the asset price is particularly high.

Investing in dividends

Investing in dividends is a simple strategy, suitable for all investors, especially passive ones or those looking for regular income.

The basis of the strategy is investing in companies that distribute increasing dividends. Have a look at the following articles to get started with dividend investing:

• Dow Jones Stocks with best dividends
• Best dividend stocks
• Beginner’s guide to dividends
• Dividend kings

Permanent portfolio

The concept of a permanent portfolio started with financial advisor Harry Browne in the 70s, who, after analysing the behaviour of different financial assets, observed that they did not move the same in each market cycle.

Thus, if we diversify adequately by type of assets, we can achieve a balanced portfolio that helps us protect ourselves from market fluctuations, since the rise of some assets’ prices can compensate for the fall of others.

Browne shared the conclusions of some of his observations, which would be, in summary:

• In times of economic prosperity, the stock market performs well
• If inflation is rising, gold can help you protect your investment portfolio.
• Bonds protect the investment value during a deflationary period.
• Cash investments (meaning short-term Treasury bills) are important during recessions.

Other recommended readings

Here are some other aspects you may want to consider before investing in the stock market:

• Consider learning about copytrading and check some of the best copytrading brokers
• Pick the right broker for your experience considering some of the best brokers for beginners or best commission-free brokers
• Consider diversification benefits and have a look at the best fixed-income brokers, best crypto brokers or best ETF brokers to create a diversified portfolio

Summary

In short, investing in the stock market is not so challenging nowadays thanks to all the information available to novices. It’s important to craft a sound investment strategy, including risk management, to ensure your success in the long term.

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