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Beginners Guide to Investing in the Stock Market

For those of you new to the stock market, we have this short and practical guide to explain some basic concepts and help get you started:

What Are Stocks?

A stock is a share in the ownership of a company.  If you own a share of a company's stock, you have a claim to a part of everything the company owns and are entitled to a portion of the company's profits, which are often paid out in the form of dividends.

A special type of  stock is exchange-traded funds. An exchange-traded fund, or ETF, is a basket of stocks that is bought and sold on a stock exchange as if it were a single stock. For instance, SPY is a bundle of 500 large U.S. stocks that track the performance of the S&P 500 Index.

Why issue stocks?

Why does a company issue stock? At some point every company needs to raise money. To do this, companies can either borrow funds or sell part of an interest in the company, which is known as issuing stock.

Risks of Owning Stocks

Just as a small business owner isn't guaranteed a return, neither is a shareholder. Shareholders can earn a lot if a company is successful, but they also stand to lose their entire investment if it isn't.

Despite the risks, historically the stock market has always been able to overcome even the worst declines. From 1926-2000, you stood a 72% chance of making money in stocks if your holding period was one year. If you lengthened your horizon to five years, the odds of making money went up to 90%. If you extended your holding period to fifteen years, you would have made money 100% of the time.

As an owner of a stock, you are not personally liable if the company is not able to pay its debts. Even if a company in which you are a shareholder goes bankrupt, you can never lose your personal assets. The amount of money you put at risk is absolutely limited to the amount you paid for the stock.

How Stocks Trade

Most stocks are traded (which in financial market jargon  means they are bought and sold) on stock exchanges, which are places where buyers and sellers meet and decide on a price. The most well-known exchanges in the U.S. are the New York Stock Exchange (NYSE), NASDAQ and American Stock Exchange (AMEX).

Brokers are the individual investor's direct link to Wall Street.  They charge a price (commission) to trade, so to trade stocks you need to sign up for a brokerage account. Whichever broker you decide to use, make sure he is covered by the Securities Investor Protection Corporation, which protects your assets in a brokerage account  in the event the firm should fail.

A Web-based broker is simple to use, as all you have to do is log in through the broker's Web site and place your orders through a simple online form. You must fill in the ticker symbol for the stock you want to buy (for instance, the ticker symbol for S&P 500 is SPY), how many shares of stock you want to trade, and the maximum price (limit price) you are willing to pay for each share:

What Causes Prices to Change?

The current price of a stock indicates what investors feel a company is worth. There are many factors that affect investors' valuation of a company. Current earnings per share (EPS) and future earning estimates are among the most important factors.

The stock market is also influenced by the current economic situation, political decisions, investor psychology and large institutional investors. Even if there is nothing wrong with a company, a large shareholder who is trying to sell millions of shares at a time can drive the price of the stock down simply because there are not enough people interested in buying the stock he is trying to sell.

The following diagram shows, in the simplest possible way, how and why share prices move up and down. Factors that effect investors opinion are released into the public domain and you and I interpet and react to this information by either buying up or selling down the share price:

If more people want to buy a stock than sell it, the price moves up.  If more people want to sell a stock than buy it, the price will fall (supply/demand).

How to read stock price charts

Perhaps the most popular charting method is the daily bar chart. The days open, high, low and close are required to form the price plot for each period of a bar chart. The open is the short horizontal line crossing the vertical bar on the left and the close is the short horizontal line crossing the vertical bar on the right. The high and low are represented by the top and bottom of the vertical line.

On a daily chart, each bar represents the high, low and close for a particular day.

Fundamental and Technical analysis

There are two general schools of stock analysis:

1.) The fundamentalist will select stocks purely on the basis of a company's financial statements (quarterly and annual reports). Fundamentalists use a wide variety of trading systems, strategies and approaches, but these are the three most common ways to evaluate stocks:

* Value investors look for bargains - stocks selling below their true value.
* Income investors target companies paying high and consistent dividends.
* Growth investors will invest in companies that exhibit signs of above-average growth.
 

2.) The technical analyst uses price charts to forecast future price direction (technical analysis). Technical analysis is based on the belief that price discounts everything. All known fundamental, political and economic information available to the market is reflected in the price. Technical analysts often rely on technical indicators. An indicator is a result of mathematical calculation, based on prices and/or volume. The figures received are used to measure current market conditions as well as to forecast price changes.

We suggest using fundamental analysis when choosing which stocks to buy, and using technical analysis (chart analysis) for finding the best time to buy and sell.

Timeframe's

Markets often trend in more than one direction at the same time: The stock market can be in an upward trend for several years; while the secondary cycle corrects downwards over several months; and a short-term rally occurs during the current week. This is why stock traders can have very different timeframe's in mind:

1. Long term investors/position traders will hold their stocks for several months or years.
2. Swing traders typically jump in and out of stocks more often, usually holding each stock just a few days or weeks.
3. Day traders will hold a stock anywhere from a few seconds to a few hours, taking advantage of small price fluctuations during the day.

Advanced trading tools

Money Management

Most investment professionals agree that money management is the most important factor helping you reach your long-range financial goals while minimizing your risk. As a investor your money management strategy is the one variable that will give you the biggest edge in trading stocks. You cannot control the stock market but you can control your money and your risk on each and every trade that you make.

1. Even if the odds are stacked in your favor, it is inadvisable to risk a large portion of your capital on a single trade. The portfolio theory tells us that after 10-12 diversified stocks, you are very close to optimal diversification. Of course you need to split your investment capital among a variety of companies from different industries.
2. Never buy a stock without a  plan to get out. Then if the market moves against you are prepared. Price corrections where the price temporarily turns down before the uptrend continues is perfectly normal. However there is no reason to hang onto any stock that is sharply declining when you could own a rising stock instead. Make a decision in advance to sell a stock if its price falls more than a predetermined percentage from its highest point (trailing-stop) or below a predetermined prosentage of the price at which you bought it (stop-loss). 
3. A general rule for equity markets is to never risk more than 1-3 percent of your capital on any one stock.

The following chart will help illustrate the importance of keeping drawdowns to a minimum:

The biggest risk that any trader faces is that they will lose their capital. Sooner or later they encounter a string of losing trades (drawdown) that either wipes them out or wipes out a big enough portion of their capital that they quit trading. By managing your money correctly on every trade you can relax because if you incur a loss it will be insignificant to your account. This will also relieve the emotional pitfalls that plaque so many investors.

Trading psychology

Don't let emotions take control of your trading. Always stick to your trading plan and avoid impulse trades. Never a trade with a gamblers mindset. Stock trading is not gambling, and the stock market is not a casino.

Emotion is the greatest enemy of the trader, particularly the emotions of fear, e.g., the fear of suffering a loss or the fear of missing out on an opportunity. Stay emotionally detached from the market. Avoid getting caught up in the short-term excitement,  or you'll be changing your mind and your position every few minutes. 

Screen-watching is a tell-tale sign; if you continually check prices or stare at charts for hours, it is a sign that you are unsure of your strategy and are likely to make emotional decisions that may result in losses. 

How to Make Money in Stocks

The most important thing you need to know about building wealth in the stock market is the power of compounding (making regular periodic investments and reinvesting the profits).

The results you'd get following this discipline are surprising. Say you start with nothing, but decide to put $500 of your income into an investment account every month, and you commit to letting your money ride. The long-term (75 years) average return for stocks is 11% annually. If you achieve that same return, you'd have $1 million if you stick with the plan for 28 years.

The longer you invest, the smaller the amount you need to put away each month to reach $1,000,000. Thus the younger you are when you start investing, the younger you'll be when you join the million-dollar club.

Of course, skilled investors are likely to beat the stock market average and achieve even higher returns in a much shorter time frame. The millionaire calculator shows you how long it will take you to become a millionaire.

What will the Stock Market do next?

Everybody knows that in the very long term, the markets will go up, but waiting for the very long term to happen can be painful. The frustration of periods when the stock market decline for several months or years in a row is just too great for some investors to tolerate.

The solution is simple: invest with the market, not against it. Market timing cant reverse the effects of a bear market, but it can reduce risk by keeping you safely on the sidelines during downturns while getting you in during bull markets. If the stock market never went down, timing might not be necessary. But as the stock market has shown so many times, major losses often happen when people don't expect them.

If you are looking for a reliable long-term market timing system, this website is for you. We are NOT a "get rich quick" scheme, but a timing tool for managing risk and preserving capital. Our timing model attempts to limit drawdown by reacting to significant changes in market conditions and calculating the probability of a long-term bull market or stock market decline. By managing your investments with us, you will grow and protect your money in both up and down markets. 

To learn more about how to use Trend-Chart.com to substantially grow and protect your assets, please sign up for the free trial subscription: