Have you decided to dive deep into the world of trading and investing? Learning how the stock market works is the first step to generating wealth, protecting it against inflation, and making passive income.
In this article, we’ll introduce you to everything you should know about the stock market – ranging from how it works to how to place your first orders.
What is the stock market?
Imagine the stock market as a supermarket. Here, companies act as producers, offering a portion of their ownership to buyers known as shareholders (investors). This arrangement allows companies to raise funds for their expansion.
The stock market ensures a safe environment for trading shares, attracting more companies willing to share ownership with individuals who want to invest their money.
How to invest in the stock market?
There are more than 70 stock exchanges in the world. The term “stock market” may refer to all of them collectively or to a specific stock exchange – such as the London Stock Exchange.
Most developed economies have one or more domestic stock exchanges. These platforms are where companies list their shares and make them publicly available.
How to invest in the stock market: step-by-step guide
Here’s a step-by-step guide to investing:
- Build an Emergency Fund:
- It’s important to have enough savings for your daily needs. The stock market isn’t the place for funds you might need in the short term. The unpredictable nature of stock prices (volatility) can lead to losses temporarily, so liquidating your positions whenever you need quick cash is not a good strategy.
- Meet Legal Age Requirements:
- In the UK, you need to be at least 18 years old to open a brokerage account and start investing in the stock market.
- Open an Account with a Broker:
- You can’t directly buy stocks in the market. You need an intermediary known as a broker. Brokers charge fees for executing stock trades.
- Transfer Funds:
- You’ll usually transfer money from your bank to the broker’s account. This can be done through bank transfers, PayPal, Sofort, Neteller, and similar methods.
- Select Stocks and Exchanges:
- A single stock might be listed on multiple exchanges, each with different liquidity and fee structures. Choose the stock and the exchange that suits your preferences.
- Place a Buy Order:
- Buy orders are placed when the stock exchange is open. (Find out more about stock exchange hours)
By following these steps, you become a shareholder in the chosen company.
What to invest in as a beginner?
Let’s explore the investment options available and identify those most suitable for beginners.
Here are the various assets you can invest in:
- Mutual funds (professionally managed baskets of assets)
- Exchange-traded funds
- Forex (foreign currencies)
- Fixed-income assets, such as bonds
- Cash and cash equivalents
- Commodities (gold, silver, wheat, sugar, coffee, iron)
- Shares of real estate investment trusts (REITs)
- Derivatives (options, futures)
- Physical assets (gold bars, artwork, collectables, coins)
There are many assets to choose from. Beginners may want to start with the stock market – stocks are some of the most straightforward assets. Then, once you become familiar with stocks, you can diversify your portfolio by adding various other assets, such as funds, bonds, or forex.
Also, if you are a beginner, have a look at the best brokers for beginners.
How do you make money in the stock market?
Profits from stocks are generated by:
- Stock Price Appreciation: You buy the stock when the price is low and sell it after it appreciates – the difference is your profit.
- Dividend Payments: Companies may share their profits with shareholders through dividends.
Also, you can also find out how much a trader earns.
How much money do you need to invest in the stock market?
The capital requirement depends on many factors, such as:
- The chosen broker – some brokers may require you to deposit a specific amount, but there any many online brokers nowadays with no minimum deposit required. Also, some brokers may have a minimum requirement for opening positions.
- Your chosen assets – if you want to buy the whole share, the capital required can be quite high in the case of expensive shares, such as Amazon. Fortunately, many brokers allow you to buy fractional shares, so you can invest smaller amounts.
- You need to consider all costs, such as commissions or trading fees, withdrawal fees, currency conversion (if applicable), and more – all these costs should be detailed by your chosen broker.
How to start investing on a budget?
If you are on a tight budget, make sure you choose the right broker for your needs. A commission-free broker, for instance, will not charge you any trading commissions.
Make sure you craft your investing strategy carefully. Even if you start with little money, you need to clearly identify when to place orders, what assets to buy, define a clear exit strategy or when to cut losses, and use risk management tools.
Perhaps the best strategy for investing on a budget is to opt for funds, such as exchange-traded funds or mutual funds. These allow you to buy into a diversified basket of assets, which is considerably cheaper than investing in each stock separately.
Fees for investing in the stock market
Here are some of the main types of fees:
- Brokerage Commission: This is a fee charged by the brokerage firm for executing your buy or sell orders. It’s typically a percentage of the transaction value or a flat fee per trade.
- Spread: When trading stocks, there’s often a difference between the buying price (ask) and the selling price (bid). This difference is known as the spread and represents the cost of trading.
- Account Maintenance Fees: Some brokers may charge fees for maintaining your investment account, although many modern platforms often have waived or very low account maintenance fees.
- Custodian Fees: If you’re investing in certain types of assets, like international stocks, your broker might charge a fee for safekeeping and managing these assets on your behalf.
- Exchange Fees: Exchanges charge fees for executing trades on their platforms. These fees can vary based on the exchange and the type of trade.
- Stamp Duty: This is a 0.5% tax on the purchase of shares.
- Foreign Exchange Fees: If you’re trading in international markets, you might incur fees related to converting your currency into the currency of the traded stock.
- Management Fees (for Funds and ETFs): If you’re investing in managed funds or exchange-traded funds (ETFs), you’ll likely encounter management fees. These fees cover the cost of running the fund and are expressed as a percentage of your investment.
- Performance Fees (for Funds): Some funds charge performance fees if the fund outperforms a certain benchmark. These fees are intended to align the interests of the fund manager with those of the investors.
- Inactivity Fees: Some brokers may charge fees if your account remains inactive (no trading activity) for a certain period.
- Withdrawal Fees: When you withdraw funds from your investment account, there might be withdrawal fees.
Advantages and risks of investing in the stock market
Advantages of investing in the stock market
- Regular Income: One significant advantage is the potential for regular income generated through stock dividends. Dividends are a portion of a company’s profits that it shares with its shareholders. The money received from dividends can be reinvested in more stocks or used for personal needs, depending on your preferences.
- Low Fees: Compared to other assets or real estate investments, stock market fees are relatively low. However, it’s crucial to consider that these fees are charged per transaction. Before you begin, it’s important to thoroughly understand the cost structure of your chosen broker.
- Total Freedom to Invest: When investing in the stock market, you have the freedom to make decisions based on your judgment. You’re not obligated to buy or sell unless you believe it’s the right time to do so. Your investment choices remain under your control.
- Investing Beyond Indices: The stock market offers opportunities to invest in excellent companies that might not meet the size or liquidity requirements to be part of an index. These companies often receive less attention from investment funds, but they can generate significant returns.
- Inflation Hedge: Investing in the stock market allows you to invest in assets that can act as a hedge against inflation, such as real estate companies and even commodities.
Risks of investing in the stock market
While there are advantages, it’s essential to recognise the risks associated with investing:
- Market Risk: The value of your investment might decrease when you decide to sell, resulting in a loss compared to your initial investment.
- Liquidity Risk: There’s a chance that you might not find a buyer for the stocks you own, requiring you to sell at a lower price than anticipated.
- Exchange Rate Risk: If you invest in stocks denominated in a currency different from your own (e.g., dollars instead of pounds), fluctuations in exchange rates could lead to losses even if your investment performs well.
It’s important to note that while investing, you might lose all the money you’ve invested if the companies you’ve invested in go bankrupt. However, you will not lose more than your initial investment, and when you hold a diversified portfolio, the risk of this occurring is significantly reduced.
To mitigate these risks, thorough education and analysis are key. Learning about the stock market, its terms, and individual companies can significantly enhance your decision-making process. Always remember that knowledge is a valuable tool in managing risk.
How to start investing: making a strategy in 10 steps
Here are 10 steps to begin investing from the ground up:
- Analyse Your Financial Profile: Understand your income, expenses, life stage, savings capacity, future plans, career trajectory, and emergency fund.
- Assess Your Psychological Profile: Reflect on your response to losses and your consistency in handling investments.
- Set an Investment Timeline: Decide on the length of time you plan to invest—1, 5, 10, or even 20 years.
- Determine Your Loss Limit: Recognise that markets fluctuate, and you should be prepared for potential losses, especially when needing funds at unfavourable times.
- Define Your Target Return: Remember that higher returns usually entail higher risks. Be realistic, as the most successful long-term investors historically haven’t generated more than 10% annual returns.
- Select Your Investment Style: Choose whether you prefer a hands-off approach, like using a Robo-advisor or investing in funds, or an active role where you pick stocks or engage in frequent trading.
- Choose Your Broker: Compare various brokers to find one that aligns with your needs and financial profile. There can be significant differences in costs.
- Prioritise Saving: Consistently saving and investing over time is essential. Starting early allows compound interest to work its magic.
- Embrace Diversification: Spread your investments across different countries, sectors, and asset types to avoid concentrating risk in a single area.
- Boost Your Income Potential: Particularly when you’re young, seek ways to increase your income over the long term to support your investment goals.
Once you’ve completed these steps and chosen your investment approach, you’re ready to begin. But before you dive in, it’s important to select an investment strategy. In the realm of the stock market, the age-old debate opens up: How do you decide which stocks to buy?
Types of stock market analysis
Let me introduce you to the two most prominent methods of stock market analysis. They’re distinct and opposite, yet both are widely used to guide investment decisions.
Fundamental analysis aims to determine a company’s value based on its performance and assets. This is achieved using various metrics:
- Price-to-Earnings Ratio (PER): Relates a company’s market capitalisation to its net profit, indicating how many years it would take for generated profits to match market capitalisation.
- Price-to-Cash Flow Ratio: Compares a company’s market value to its cash flow. A lower ratio suggests a better value.
- Price-to-Book Value Ratio: Compares share price to equity value. A ratio below 1 indicates a potential buying opportunity.
- Return on Equity (ROE): Measures the return shareholders receive from their investment in the company.
- Net Dividend Per Share: Net profit distributed for each share.
- Dividend Yield: Percentage of share price given as dividends annually.
- Net Profit (Millions): Profit remaining after expenses and taxes.
- EBITDA (Millions): Gross operating profit before expenses.
- Earnings Per Share (EPS): Profit attributed to each share.
You don’t have to do these calculations yourself, you have the option of using stock screeners to make your search easier.
Technical analysis involves studying price charts and disregards company performance or assets. Some examples of common technical tools are:
- Trend analysis
- Resistance and support levels
- Chart analysis
Have a look at our beginner’s guide to technical analysis for a more in-depth explanation of technical analysis.
The choice between the two types of analyses usually depends on your preferences, skills, and approach. Generally, long-term investors use fundamental analysis to find undervalued companies. Shorter-term traders use technical analysis to capitalise on short-term price movements.
However, some may also use a combination – for instance, you can use fundamental analysis to find the right stocks for your strategy, and then use technical analysis to identify the right timing (i.e., when to open or close your positions).
How to choose a broker?
To invest in stocks, a broker is necessary—an entity that facilitates stock market transactions and charges fees for this service. When choosing a broker, you should do thorough research and pick the right one according to your needs and strategy.
Types of brokers
As you venture into the stock market, you’ll come across various types of brokers. Here’s a brief overview to help you navigate:
- Commission-Free Brokers: These brokers don’t charge commissions, but they charge spreads or other types of fees instead.
- Multi-Product Brokers: They offer a range of investment options, including stocks, ETFs, and derivatives.
- Forex Brokers: These brokers specialise in currency trading.
- STP/ECN Brokers: They route your orders to liquidity providers, enhancing transparency in trading. These may charge commissions or a mix of fixed fees and spreads.
- Market Makers: These brokers serve as counterparties in your trades. These brokers do not typically charge commissions, but they charge spread fees instead.
- Best brokers for beginners
- Best commission-free brokers
- Beginner’s guide to dividends
- A quick guide to global stock indices
- Best trading books
- Money management strategies
Stock market for beginners: summary
As you stand at the threshold of the exciting world of stock market investing, remember that patience, education, and prudent decision-making will be your guiding lights. With the right information and a commitment to learning, you’re well-equipped to embark on a rewarding journey in the captivating world of the stock market.
Can you invest in the stock market at any time?
Can I lose more money than I invest in the stock market?
No, you cannot lose more than the amount you invest if you choose a regulated broker. While the stock market carries risk, your losses are limited to your initial investment. Diversifying your portfolio and understanding the assets you invest in can help manage risk and potentially enhance returns over time.
Is investing in the stock market only for the wealthy?
No, investing in the stock market is accessible to various income levels. Some brokers offer fractional shares, allowing you to invest even small amounts. Starting early and consistently contributing to your investments can help build wealth over time, regardless of your initial investment size.
How can I manage emotions like fear and greed when investing?
Emotional discipline is essential in investing. Establish a clear investment strategy and stick to it, avoiding impulsive decisions. Diversification and long-term perspective can help mitigate emotional reactions to market fluctuations.
What’s the significance of diversification in my investment portfolio?
Diversification involves spreading your investments across different assets, sectors, and regions. It reduces the impact of poor performance in any single investment, enhancing the stability of your portfolio. Diversified portfolios are better equipped to weather market volatility.
What should I do if I encounter losses in my investments?
Losses are a natural part of investing. Avoid panic-selling, as markets can rebound over time. Reassess your investment strategy, and ensure it aligns with your long-term goals. Periodic portfolio review and staying informed can help you make informed decisions during challenging times.