Investing in stock market has always been one of my favorite ways to grow my money. If you are a beginner looking for tips to make money in stock market, here’s a detailed step-by-step plan to get you started in your investing journey.
Before that, I want to share a story with you.
Recently, a friend of ours said to us, “I want to invest in stocks. Any good stocks to buy? “
He is a doctor and makes good money, but he has never invested in stocks before.
His original plan was to just save enough money and buy more properties for rental income because his mum is a seasoned real estate broker and has advised him to put his money in real estate.
So, when he told us that he wanted to get into stock investing, we were a bit surprised.
Although we are not sure why he suddenly wants to start investing in stock market, that is not important right now.
What is important is that he is approaching stock market investing the wrong way.
Because you should not put your hard earned money in investments that you know nothing about.
Of course, we didn’t give him any stock recommendation.
Here’s the problem with buying stocks blindly based on friend’s recommendation or tips.
Possibility #1: The stock your friends recommend might be a winning stock.
But, it’s possible that the stock price could go down and stay down for a prolonged period of time before it goes up eventually.
During this downtrend, do you have the conviction of holding onto the stock to capture the long term gain?
As the only reason why you bought the stock is that your friend thinks that it is a good stock, you will not be able to stay calm in the face of increasing paper losses.
Possibility #2: The stock your friends recommend might be a losing stock.
This is a very real possibility because no one can predict where the stock price will go in the future.
In the case that the stock goes south, do you have the knowledge and experience to recognize the warning signs of a losing stock? And also have the discipline to cut your losses short?
Chances are not.
Because the only reason why you invested in the stock in the first place is that your friend told you to.
So, instead of giving him stock recommendations, we suggested that he should learn about stock market investing first.
Basics About Stock Investing
Now let’s talk about some basics about stock investing.
What Is Stock Market? And How It Works.
” According to Wikipedia, a stock market is the aggregation of buyers and sellers (a loose network of economic transactions, not a physical facility or discrete entity) of stocks (also called shares), which represent ownership claims on businesses.”
So, how does a stock market work?
Companies who need to raise money issues shares. These shares, in turn, are being traded on stock exchange such as New York Stock Exchange and NASDAQ.
Trader and investors buy and sell these shares based on how much they think the shares are worth or which direction the share price will go.
Four Different Ways To Make Money In Stock Market
- Buy low and sell high
This is quite straight forward.
You buy a stock at a low price and sell it at a higher price for a nice profit.
It works the same way as you buy goods at wholesale prices and re-sell it for profit at much higher retail price.
If you have a strong conviction that the stock price will go up over time, you can buy it now and then sell it off when the price has gone up to your take-profit price.
- Short sell high and buy back at low price
You can also make money by short selling the stock at a high price, and then buying it back at a lower price later on.
When you short sell a stock, you will need to borrow the stocks first before you can short sell it. This is a regulatory requirement.
There is one exception.
If you are doing day trading, you are not required to borrow the stocks because you will have bought back the stock before market close.
Note: The regulatory requirements regarding short selling differ from country to country.
So, you will have to check and make sure that you comply with it.
- Earn dividend income from the stocks
There is a group of stockS called dividend stocks in the stock market.
The underlying companies of these dividend stocks pay out dividend payments to shareholders once or twice a year based on their dividend schedule.
Examples of dividend stocks are The Coca-Cola Co, Philip Morris International and IBM.
- Sell options on stocks
Option is a contract where the seller of the option contract agrees to buy/sell the underlying stock at a pre-agreed price (i.e. strike price) at a pre-agreed expiration date from the buyer of the option contract.
When you sell option on stocks, you collect premiums from the option buyer.
In other words, you get paid upfront when you sell options.
If the option contracts expire worthless, you keep the money for free.
A Step-by-Step Plan To Make Money In Stock Market
Step 1: Understand your investment objectives
First, you need to understand your investment objectives.
What goals do you want to achieve through your investments?
Do you want long term capital appreciation?
Or would you like to generate stable dividend income from your investments every year?
Or are you interested in short term investment gains?
Or are you looking for monthly investing income?
The reason why you need to figure out your investment objective is that you will be able to find an investment strategy that can help you get the results you want.
Step 2: Learn the fundamentals about stock market investing
Now, you have identified your investment objectives.
What you do next is to learn the fundamentals about investing in stock market.
So, what fundamentals do you need to know?
Here’s a few important topics:
- Basics about stock market
- Stock market behavior
- Investment strategy
- Risk management
- Money management
- Investment psychology
Without the necessary knowledge, you will find it difficult to understand the hows and whys.
Step 3: Choose an investment strategy that suits your objectives and your profile
There are many different investment strategies for you to choose from.
Let say, you want to generate stable dividend income from your stock investments year after year.
Based on that, the best investment strategy for you would be dividend growth investing strategy.
Here’s its definition from wikipedia:
“Dividend growth investing strategy involves investing in company shares according to the future dividends forecast to be paid. Companies that pay consistent and predictable dividends tend to have less volatile share prices.”
By investing in dividend growth companies specifically, you will be able to build a portfolio of dividend stocks that pay out consistent dividend income year after year.
Step 4: Build a portfolio
With your chosen investment strategy, it is time to build your stock portfolio.
Here are some questions to help you with your portfolio construction process:
- How many stocks do you want to include in your portfolio?
- What sectors do these stocks come from?
- What is the weight given to each sector or each stock in your portfolio?
When you build your portfolio, you don’t want to have just one stock in your entire portfolio or just stocks from one particular sector.
Because you are putting all your eggs in one basket. Doing so will give you high concentration risk.
To avoid high concentration risk, the key is to have a diversified portfolio.
Similarly, having too many stocks is not good either.
Because it will not help optimize your portfolio performance.
100 different stocks will give you average returns that match the stock market index performance, while 15 to 20 hand-picked good stocks could give you exceptional returns.
When it comes to portfolio construction, you always have to strike a balance between performance and risk.
Step 5: Risk management
Money and risk management is one of the most important aspects of investing.
Without good money and risk management, it’s certain that you won’t succeed in investing.
So, what is good money and risk management?
Good risk management means that you should always set the maximum risk you are taking on the individual stock level, sector level and portfolio level.
For example, your entire investment account is $20,000.
The maximum risk you want to take on the individual level is 5% of your entire account. If your loss is about to exceed 5%, you will cut loss.
Many people end up losing a lot of money mostly because they don’t cut loss when they should have.
Here’s the Risk to Ruin table. It helps you understand why managing your risk and controlling your risk is vitally important to your investment success.
Step 6: Review your portfolio
Once you have built your portfolio, your job is not over yet. You still need to periodically review your portfolio.
Sometimes, some stocks in your portfolio might go up substantially while other stocks never really move much or might even go down.
In cases such as this, you might encounter a situation where your exposure to a particular stock or a particular group of stocks is too high.
What you would need to do is to re-balance the portfolio by reducing your holding in this particular stock or this particular group of stocks and increasing your holding proportionally in the other stocks.
Another reason why you need to re-evaluate your portfolio regularly is that your investment objectives might change over time.
When this happens, your current portfolio might no longer be appropriate.
To make money in stock market is not as easy as some people have thought. But, it is not difficult either. If you have the right mindset, right strategy and proper risk management, you should be able to see good results.