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Investing in the 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 the 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 asked 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 the stock market, that is not important right now.
What is important is that he is approaching the 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 recommendations.
Here’s the problem with buying stocks blindly based on friend’s recommendations 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 that need to raise money issues shares.
These shares, in turn, are being traded on a 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
Method #1: 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 a 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.
[Side Note: Motley Fool Stock Advisor, a stock picking service which I’ve been using for years, has given me quite a lot of profitable stock ideas that I would have otherwise missed out. As of May 2020, average Motley Fool Stock Advisor recommendations have returned over 399.5%, with over 100 stock recommendations with 100%+ returns.]
Method #2: 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.
Method #3: 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.
How Do You Pick Stocks (With High Return But Low Risk)
Method #4: Sell options on stocks
Options 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 options on stocks, you collect premiums from the options 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 in the stock market?
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 (i.e. trading stocks for short-term profits)?
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.
For example, if you are investing for retirement and looking for long term capital appreciation, then you will have a very different investment strategy than someone who just wants to trade stocks for quick capital gains in the immediate term.
Step 2: Learn the fundamentals of stock market investing
Now, you have identified your investment objectives.
What you do next is to learn the fundamentals of investing in the stock market.
So, what fundamentals do you need to know?
Here are a few important topics:
- Basics about the 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.
Here is a list of popular investment strategies:
- Value Investing strategy
- Dividend growth investing strategy
- Passive Investing Strategy
- Buy-and-Hold strategy
Let’s 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 a 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.
Earlier on, we were talking about how your investment objectives will determine your investment strategy.
For example, if you are investing for retirement and looking for long term capital appreciation, then you might want to choose a passive investing strategy for your 401k and/or Roth IRA (Retirement Accounts)
One of the best passive investing strategies is to invest the money in your retirement accounts in low-cost S&P Index ETFs (yes, even Warren Buffet recommends it).
On the other hand, if your objective is to trade stocks for quick capital gains based on technical analysis in the immediate term (e.g. in a few minutes or in a few hours), then you will be buying and selling stocks quickly and profiting from the price movement during the market hours.
And you will be using a day trading strategy to help you do that.
A day trading strategy is generally based on technical analysis (i.e. reading the price charts) and use the price movements or patterns to predict what direction the stock price will move in the next few minutes or hour.
Step 4: Build an investment portfolio
With your chosen investment strategy, it is time to build your investment portfolio.
First, I want to introduce you to two concepts:
- Investment portfolio
An investment portfolio is a set of financial assets owned by an investor that may include stocks, bonds, real estate, or alternative investments.
Diversification means that you spread your money across different types of investments with little or no relations to each other.
Why do you want diversification in your investments?
Because you don’t want to put all your eggs in one basket and diversification can help you reduce your investment risk.
And the right way to invest your money is to build a diversified investment portfolio.
Let me give you an analogy.
When you were young, you were told that to be healthy and strong, you need to eat a balanced meal that includes grains, dairy, meat, vegetables, and fruits.
Each type of food has its own unique benefits to your body.
Together, it gives your body all the nutrition it needs.
But, if you eat just one type of food or totally avoid eating a single type of food, your health will likely suffer in the long term.
Similarly, you need a balanced investment portfolio to reap benefits from different kinds of market conditions as well as protect you from various adverse market conditions.
For example, when inflation is higher than expected, your real estate and gold investments will perform better than other investments.
When economic growth is worse than expected, your treasure bonds will perform better than other investments.
So, you should always avoid investing all your money into any single investment category.
Instead, what you should do is to build a diversified investment portfolio that matches your risk tolerance level and your investment goal.
Of all the investment asset classes, stocks, real estate, and alternative investments are considered to be riskier while investment-grade bonds are considered to be less volatile and safer.
So, if you are a risk-averse investor, you might want to allocate a bigger portion of your portfolio to bonds.
However, if you are comfortable with taking higher risks, you might want to allocate more to stocks.
Now, how do you build your investment 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 doing so will give you a 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.
If you don’t want to construct your own investment portfolio, M1 Finance provides quite a number of expert portfolios that you can choose from based on your risk profile and investment goals.
Of course, you can also use M1 Finance to build your custom portfolios and automate your investing and portfolio re-balancing for free (yes, it’s completely free).
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.
Best Investment Strategies For Beginner Investors
Recommended Resources To Help You Make Money In Stock Market
So, to make money from the stock market, you first need to know what good stocks you can invest in.
But, no one can possibly scan the entire stock market for good investment opportunities because you simply don’t have the time. (by the way, there are close to 4,000 stocks listed on US stock exchanges alone)
Also, there are always other people who have more knowledge and experience in a particular industry than you, so you would probably miss some great stock ideas that are hard to discover on your own.
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How would your investment portfolio be like today?
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To make money in the stock market is not as easy as some people have thought. But, it is not difficult either. If you have the right mindset, the right strategy, and proper risk management, you should be able to see good results.