How do stocks work for beginners? The stock market may seem more confusing than it really is. How do stocks work for beginners? This post explains how to understand stocks for beginners in a simple way.
How do stocks work for beginners? To answer this question we’ll look at how the stock market works and what stocks are. We’ll review how your broker makes money and the different types of brokers. Plus we’ll compare and contrast different stock prices, including Active and Quotes price, Open and Close price, and Bid and Ask price. Whether you’re a beginner or an experienced investor, knowing these terms will help you when investing.
Stock market basics
The stock market is made up of exchanges, like the New York Stock Exchange and the Nasdaq. Stocks are listed on a specific exchange, which brings buyers and sellers together and acts as a market for the shares of those stocks. The exchange tracks the supply and demand — and directly related, the price — of each stock.
But this isn’t your typical market, and you can’t show up and pick your shares off a shelf the way you select produce at the grocery store. Individual traders are typically represented by brokers — these days, that’s often an online broker. You place your stock trades through the broker, which then deals with the exchange on your behalf. (Need a broker? See our analysis of the best stockbrokers for beginners.)
The NYSE and the Nasdaq are open from 9:30 a.m. to 4 p.m. Eastern, with premarket and after-hours trading sessions also available, depending on your broker.
Understanding the stock market
When people refer to the stock market being up or down, they’re generally referring to one of the major market indexes.
A market index tracks the performance of a group of stocks, which either represents the market as a whole or a specific sector of the market, like technology or retail companies. You’re likely to hear most about the S&P 500, the Nasdaq composite and the Dow Jones Industrial Average; they are often used as proxies for the performance of the overall market.
Investors use indexes to benchmark the performance of their own portfolios and, in some cases, to inform their stock trading decisions. You can also invest in an entire index through index funds and exchange-traded funds, or ETFs, which track a specific index or sector of the market.
Stock trading information
Most investors would be well-advised to build a diversified portfolio of stocks or stock index funds and hold on to it through good times and bad. But investors who like a little more action engage in stock trading. Stock trading involves buying and selling stocks frequently in an attempt to time the market.
The goal of stock traders is to capitalize on short-term market events to sell stocks for a profit, or buy stocks at a low. Some stock traders are day traders, which means they buy and sell several times throughout the day. Others are simply active traders, placing a dozen or more trades per month. (Interested in individual stocks? View our list of the best-performing stocks this year.)
Bull markets vs. bear markets
Neither is an animal you’d want to run into on a hike, but the market has picked the bear as the true symbol of fear: A bear market means stock prices are falling — thresholds vary, but generally to the tune of 20% or more — across several of the indexes referenced earlier.
Bull markets are followed by bear markets, and vice versa, with both often signaling the start of larger economic patterns. In other words, a bull market typically means investors are confident, which indicates economic growth. A bear market shows investors are pulling back, indicating the economy may do so as well.
The good news is that the average bull market far outlasts the average bear market, which is why over the long term you can grow your money by investing in stocks.
Stock market crash vs. correction
A stock market correction happens when the stock market drops by 10% or more. A stock market crash is a sudden, very sharp drop in stock prices, like in October 1987 when stocks plunged 23% in a single day.
While crashes can herald a bear market, remember what we mentioned above: Most bull markets last longer than bear markets — which means stock markets tend to rise in value over time.
If you’re worried about a crash, it helps to focus on the long term. When the stock market declines, it can be difficult to watch your portfolio’s value shrink in real time and do nothing about it. However, if you’re investing for the long term, doing nothing is often the best course.
What Kind of Investor Are You?
Before you commit your money, you need to answer the question: What kind of investor am I? When opening a brokerage account, an online broker like Charles Schwab or Fidelity will ask you about your investment goals and what level of risk you’re willing to take.
Online Brokers
Brokers are either full-service or discount. Full-service brokers, as the name implies, give the full range of traditional brokerage services, including financial advice for retirement, healthcare, and everything related to money. They usually only deal with higher-net-worth clients, and they can charge substantial fees, including a percentage of your transactions, a percentage of your assets they manage, and sometimes, a yearly membership fee. It’s common to see minimum account sizes of $25,000 and up at full-service brokerages. Still, traditional brokers justify their high fees by giving advice detailed to your needs.
Robo-Advisors
After the 2008 financial crisis, a new breed of investment advisor was born: the robo-advisor. Jon Stein and Eli Broverman of Betterment are often credited as the first in the space.2 Their mission was to use technology to lower costs for investors and streamline investment advice.
Investing Through Your Employer
If you’re on a tight budget, try to invest just 1% of your salary into the retirement plan available to you at work. The truth is, you probably won’t even miss a contribution that small.
Minimums to Open an Account
Many financial institutions have minimum deposit requirements. In other words, they won’t accept your account application unless you deposit a certain amount of money. Some firms won’t even allow you to open an account with a sum as small as $1,000.
Commissions and Fees
As economists like to say, there ain’t no such thing as a free lunch. Though recently many brokers have been racing to lower or eliminate commissions on trades, and ETFs offer index investing to everyone who can trade with a bare-bones brokerage account, all brokers have to make money from their customers one way or another.
Mutual Fund Loads
Besides the trading fee to purchase a mutual fund, there are other costs associated with this type of investment. Mutual funds are professionally managed pools of investor funds that invest in a focused manner, such as large-cap U.S. stocks.
There are many fees an investor will incur when investing in mutual funds. One of the most important fees to consider is the management expense ratio (MER), which is charged by the management team each year based on the number of assets in the fund. The MER ranges from 0.05% to 0.7% annually and varies depending on the type of fund. But the higher the MER, the more it impacts the fund’s overall returns.
Diversify and Reduce Risks
Diversification is considered to be the only free lunch in investing. In a nutshell, by investing in a range of assets, you reduce the risk of one investment’s performance severely hurting the return of your overall investment. You could think of it as financial jargon for “don’t put all of your eggs in one basket.”
In terms of diversification, the greatest amount of difficulty in doing this will come from investments in stocks. As mentioned earlier, the costs of investing in a large number of stocks could be detrimental to the portfolio. With a $1,000 deposit, it is nearly impossible to have a well-diversified portfolio, so be aware that you may need to invest in one or two companies (at the most) in the first place. This will increase your risk.
How to invest in the stock market: 8 tips for beginners
- Buy the right investment
- Avoid individual stocks if you’re a beginner
- Create a diversified portfolio
- Be prepared for a downturn
- Try a simulator before investing real money
- Stay committed to your long-term portfolio
- Start now
- Avoid short-term trading
Conclusion
It can be difficult to break into the stock market and make money. There are a lot of different types of stocks, and many things can affect their prices, which can make it difficult to know how to invest. But you also need to consider the fact that it can be really hard to understand stocks if you’re a beginner. A company’s stock is an integral part of its value, but it is often hard to understand, and this is because there are many factors involved in determining the price of a stock. Here is a quick guide on how stocks work for beginners.