Q&A: How to Make Money In Stocks
Brand-new traders and novice investors have to avoid a tantalizing trap: The notion that you can make millions in a few months by picking the right stocks or making several high-risk trades that pay huge dividends. It’s true that some people have found success — or perhaps gotten lucky — approaching the market this way, but there are plenty of more reliable and less risky ways to make money as a full- or part-time trader. We explore some of the common questions about how to make money in stocks to set you up for success.
Can You Make a Lot of Money in Stocks?
Yes! Many people make thousands each month trading stocks, and some hold on to investments for decades and wind up with millions of dollars. The best bet is to shoot for the latter category. Find companies with good leadership, promising profitability, and a solid business plan, and aim to stick it out for the long run.
Though there are plenty of exciting outliers who make money through several rapid or risky trades, this isn’t the case for most investors. Day trading or short selling, which is often the subject of wildly successful and exciting trade stories, deal in volatile, high-risk markets. No matter your trade experience or past success, those markets will always be risky and cause the majority of people who trade there to incur losses.
A far safer and more proven strategy is to make trades with the intention of holding onto your stock for a long time — five years at the least. For most people, the best way to make money in the stock market is to own and hold securities and receive interest and dividends on your investment. This is a long-term process, but it’s one that more consistently leads to big gains compared to rapid or impulsive trading. If this type of trading sounds appealing to you, follow these best practices:
- Focus on total returns: The value that your stock increases over the years is only part of its value. If you invest in dividend stocks, you’re also entitled to a percent of the company’s profits each quarter.
- Invest for the long run: You won’t buy and sell stock in the same trading session using this strategy. Plan on holding your stock for at least five years. Many people have exceeded million-dollar portfolios using this strategy and keeping their investment for 25-50 years or longer.
- Pick the best companies for this strategy: Target companies with a track record of profitability and proven leadership. Startups might seem more exciting, but they’re risky for this type of investing.
- Pay attention to asset placement: Some companies don’t pay cash dividends at all, while some will always pay back a percentage of the dividends owed to shareholders. This is a pretty big difference in managing style, but both types of companies can still make for good investments. Think about asset placement to decide which type of business is worth investing in. You can even diversify your investments and trade in both types of companies, placing your assets wisely to optimize compound annual after-tax returns.
- Pay attention to the dividend-adjusted price-to-earning-to-growth ratio: The price-to-earnings ratio (P/E) is a formula for calculating the value of a stock. It can show you, for instance, if a stock is potentially undervalued. This is a helpful analytical tool, but it’s somewhat limited. You can add an extra step to more accurately predict the value of an investment: Calculate the P/E ratio, and then divide the growth in earnings per share.
What Types of Companies Are Best for Making Money in Stocks?
It depends on your strategy. For example, if you’re interested in dividend stocks and intend to hold on to your investment for years, you’ll want to purchase stock in established companies. Compared to new startups or younger enterprises, these experienced companies will have more to pay each quarter in dividends to their stockholders. Though these businesses also have fewer opportunities for expansion since they’re already established, this type of investment is much less risky compared to backing a new company.
Another important step is to think practically about a company — regardless of its time in operation — and its projected revenue growth. For example, if a business in the retail space has projected significant growth, it may need to add new stores, increase its human capital, or make other changes to meet those goals.
The projected growth is also based on expected sales and consumer habits. These could change, but more importantly for investors, those projections could be unrealistic — i.e., estimating more growth than customers can actually sustain. So, even with the best analytical tools at your disposal, you’ll need to be realistic about these types of limits.
Can You Make Money Fast With Stocks?
Yes, it’s possible. If you want to learn how to make money fast with stocks, you’ll have to research companies in especially volatile industries or look into high- or low-value investments that carry lots of risk with the potential for a huge reward. You’ll also need a different strategy than what other types of traders use.
Those who buy stock with a plan to hold them for years, for example, look at data to predict how the company will perform over decades or longer. If you want to make money fast, you’ll want to look at specific opportunities to do so — for example, a high-value company with stock that recently plummeted (assuming the stock value will likely rebound).
Another strategy is to invest in a startup offering initial public offerings with the potential to grow quickly within a few quarters. But again, this is high risk. A larger enterprise in the industry may acquire the company, or perhaps the business you’re backing will face lawsuits or simply fold within a few years. These are real risks, and it’s far more common for a go-getting young enterprise to fail than it is for it to last even five years.
How Do Stocks Make Money?
Image via Flickr by vishpool
Many new traders are under the impression that you buy when a stock is priced low, sell when its value increases, and enjoy a tidy profit. But this is an oversimplification of how trades are made, and thinking the process is this simple can prove costly.
For example, you can’t just buy or sell stocks when you feel like it. You need to find a company with stock to purchase if you want to buy, and if you want to sell, you’ll need to find a buyer. This can be a problem for investors holding a stock whose value is plummeting, since the holder might not be able to find a buyer willing to purchase their stock. A broker doesn’t have to buy your shares if no one wants to purchase them.
Also, stocks don’t just make money for their holders by being sold at a higher price than initially purchased. You’re also entitled to quarterly dividends — a share of the profits that aren’t reinvested or otherwise spent to improve the company — with some types of stock.
Keep in mind that if your priority is dividends, the success of your stock won’t necessarily depend on its value. For example, you could receive thousands in quarterly dividend payments amounting to millions if you keep that investment for a couple of decades. In that time, however, the stock’s value might stay the same or fall — but you’d still get dividend payments as long as the business remained profitable.
Remember this when looking at your portfolio stock charts or the shareholder returns that the financial media reports. These data sources only look at a stock’s increase or decrease in value. So, even though the stock may have paid millions in dividends to its owner, the investment may look like a failure when you check these reports.
What Happens When You Purchase Stock?
Buying a share of stock is actually purchasing a part of that company and entitles you to a percentage of any earnings they make. The amount you can earn depends on what percent of profit each share is worth, how many shares you hold, and how well the company performs while you’re holding the stock. You could make more or less money than initially projected based on the company’s growth or profits.
This latter point is the most important to keep in mind. For instance, if you purchase 100 shares for $5,000 at a return of $500 in annual dividends, it would take 10 years to recover your initial investment (assuming you didn’t reinvest your earnings). If the company expanded or performed better than expected or some outside factor led to a huge expansion, you’d make much more than $500 in your share of the profits. The stock value would also increase, giving you the option to sell your investment for more than what you initially paid.
What Makes a Stock Increase or Decrease in Value?
Numerous factors affect a stock’s price, from company changes internally to marketwide influences, economic changes, government policies, and even the actions of other investors. This means humility and patience are key to successful trading. Never be too prideful to ask peers for opinions on trades or to double check with your community resources to confirm you’ll make the right choice.
What Are the Major Risks to Making Money With Stocks?
The major drawback to investing in stocks is that they’re much more volatile than investments like real estate or putting money into a retirement or savings account. Trading volume fluctuates constantly, and other factors can make the prices of stocks rise and fall quickly.
If you’re just starting out trading, you’ll need to plan for losses. They’re virtually unavoidable, though you can minimize them by making good trades and being careful and patient. If you’re feeling invincible or itching to take a risk, just remember that mistakes can totally drain your portfolio or lead to missing a million-dollar opportunity.
When Do You Get Money From Stocks?
Dividends are paid quarterly, but how the board of directors manages the amount that would be awarded to you can affect what you actually receive. They may send you a portion or the full total of your dividends, for example, or they might use the profits before they split them into dividends for shareholders to purchase shares from the open market, reinvest in the company through expansion (i.e., adding new buildings, equipment, or employees), or pay down their debt.
This may seem like a bad thing, but it’s often good for investors. It all depends on the company’s leadership and ability to manage and reinvest profits. If a company uses its profits to expand instead of paying those funds to investors, there could be far greater profits next quarter. Reinvesting profits at a high rate is how companies like Microsoft and Apple went from small operations to billion-dollar enterprises — which was a choice that early stockholders were certainly happy with.
This is another reason to settle into your investments for the long run. If you purchase initial public offerings — the first stocks a company ever offers — and that business has a fantastic first year, it’s good news for you as an investor. The enterprise will probably reinvest those profits, though, so you might not get much (or anything) in terms of dividends. Of course, you’ll still have the option of selling your stock and benefiting from the capital gains. But if the company is off to a strong start and the future is promising, you’ll probably want to keep your shares.
When you actually get money from dividends by holding stock, you’ll receive a check in the mail or a direct deposit payment to your brokerage or bank account. You can also choose for dividends to be used to purchase more shares, thus increasing the value of your investment.
Do You Have to Trade Full-Time to Make Money From Stocks?
No. Another myth of trading is that you need to constantly be monitoring how the Dow Jones or NASDAQ are performing to succeed. Though staying current on market news is important, you don’t need to obsess over how the markets are performing to succeed as an investor. The only exception is if you’re a day trader since you’ll want to monitor changes over days or even hours. But even these investors tend to specialize in a certain niche and don’t fixate on the performance of every market and industry.
Many people find success investing in stocks from companies they thoroughly research and then hold on to those shares for years. In this way, a person’s portfolio will grow as they continue with whatever their day job is. You can spend a few hours each week looking at potential companies, just review your portfolio every few days, or trade in your off-work hours. There are numerous approaches to making money trading stocks and countless ways to fine-tune your analytical methods to find potential investments that fit into your trading strategy and preferences.
What’s the Best Way to Make Money in the Stock Market?
It depends on how you want to trade — i.e., whether you want a positive return within a day, week, or month or you’re happy to sit on your investment for years. Again, as a new trader, it’s easy to get addicted to the idea that you’ll learn how markets work, make some sharp trades that other investors missed, and earn thousands in a few days. This happens on rare occasions but imagining that it will happen to you is a mistake.
If you want the best shot at learning how to make money in stocks, aim to invest in a profitable company offering dividend stocks and follow these best practices:
- Focus on dividend gains rather than capital gains: Investor returns are tied to the profitability of the business they’re investing in. It’s safest to invest in a company that shows potential for growth and then wait it out while the company expands, reinvests its profits, and makes money for you as an investor. The value of your stock will rise and fall over the years, but if you hold on and the company remains profitable, you’ll see a significant return on your investment.
- Reinvest your dividends: If you do receive dividend payments within the first few years of investing in a company, you can reinvest the amount to purchase more stock. This way, you’ll be entitled to more dividends or can sell more stock as the business grows.
- Join a stock trading group or online community: A stock trading group is a wonderful way to get support from peers and advice from professionals who’ve been trading for a long time. You’ll also benefit from each member’s knowledge and experience. You can find plenty of other resources online as well, such as webinars and e-books, where you can learn about introductory trading or find tips on how to generate greater profits through your investments.
- Consider how long you’d like to invest: If you’re young and have years to build a portfolio, you can invest in diverse stocks and benefit from long-term profitability despite some short-term volatility along the way. If you’re older and planning for retirement, conservative stocks with predictable returns are a safer bet.
As a Long-Term Investor, When Is the Best Time to Sell Stock?
Holding on to a stock while the company becomes more profitable year-after-year is ideal, but in reality, some businesses that were once profitable fail or see their stock diminish in value. So, while you need the skills to pick a good company to invest in, you also need the wisdom to know when to walk away and the patience to know not to panic when stock prices drop.
For instance, during a market bubble, you might be able to sell your stock for more than it’s actually worth. This is because a bubble is caused by investor demand driving up the value of a stock past what it’s actually worth. Once (and if) the bubble bursts, the stock price will drop. Some of the best short sellers in history have capitalized on this market phenomenon and accurately predicted that the price of an inflated stock would plummet.
How Do You Buy and Sell Stock?
If you’re brand-new to trading, you’ll want to start with some risk-free practice. You can set up an account on a site like ScottradeELITE or OptionsHouse where you can trade without spending any money. Once you’re ready to invest for real, follow these steps to get started buying and selling stock:
- Research market trends: Before you make any trade, you should understand the market and be able to pinpoint exactly why the trade you want to make is wise.
- Research companies: Look for a company that is profitable, is likely to be profitable in the future, and has good leadership and a solid business plan. You’ll also want to compare the company’s performance to its peers and to trends in its market.
- Register with a trading company: E*Trade, Scottrade, and other brokerage sites can facilitate trades. You can also work with a local licensed brokerage firm. Just be mindful of transaction fees and other charges you’ll owe for using the service.
- Buy or sell stock through your trading company: You can now purchase stock through your broker and pay any applicable fees. You must place either a market order, where you buy stock at its current price, or place a limit order, where you instruct your broker to make a trade once the stock hits a certain value. You may also purchase stock directly from some companies, which has the benefit of avoiding brokerage fees.
These are the steps for buying individual stocks, but it’s not the only option at your disposal. You can also buy stock funds, such as investing in a mutual fund (a professionally managed stock portfolio) or exchange-traded funds.
How Can You Turn Things Around if You’re Losing Money in Stocks?
Watch professionals trade, and learn why they’re making certain investing choices. You can sit in on webinars to watch pros and apply their techniques and strategies to your own portfolio. This is the best way to learn, and with the growth of trading communities and resources, you can easily find help online to get started or to turn things around if you’re losing money with your trades.
Once you have the basics down, you’ll be better at making money with stocks in a smarter, safer manner.
For more stock trading tips, turn to the experts at RagingBull.com.