History is made up of many people who have achieved a lot of financial success by investing in the stock market. In the 20th century, people like Thomas Rowe Price, John Templeton, and Benjamin Graham among others made a fortune by investing in stocks. Today, large investors like Carl Icahn, Warren Buffet, Ken Griffin, and Ray Dalio are known for the billions of dollars they have made in the market. This article will look at the stock market and how you too can invest in it.

What is a stock?

Every day, people start business ventures. To become successful, these ventures require capital. Entrepreneurs with savings can fund the operations of these businesses. As the businesses grow, they require additional capital to fund the expansion. One way to fund this expansion is by using banks who lend them money at certain interest rates. Another way is to give up equity to venture capitalists. These are people – or firms – who invest and take a small portion of the company.

As the business grows, it then requires additional capital that can only be provided by more investors. This is when the company issues an Initial Public Offer (IPO). This is a complex process where the company raises money from additional investors in the stock market.

After the IPO process, the initial investors can exit their investments at a profit or hold the company stocks if they believe in its future. They can do this easily because of the liquidity that exists in the stock market.

How to invest in stocks

There are thousands of stocks that are listed in different stock markets from around the world. The toughest part for most investors is on how to select companies to invest in. To solve this problem, you need to first understand the type of investor that you are. Some investor types include:

  • Value Investors: These are investors like Warren Buffet who buy undervalued stocks and hold them for decades. These investors first do the work of finding whether the company is undervalued. If it is, they consider the reasons why it is undervalued and then find a catalyst that will take it higher.

  • Speculative Investors: These are investors who buy stocks for speculation purposes. They intend to benefit from the short-term fluctuations of the stock prices.

  • Traders: These are people who buy and exit stocks within a short period of time. Unlike value investors, traders don’t necessarily consider the fundamental value of the companies.

  • Long-Short Investors: These are investors who invest in companies they believe will go up while simultaneously selling short companies they believe will move lower.

After understanding the type of investor you are, you need to then understand the types of companies that are available in the stock market. There are a number of ways the stocks are classified. For example, they can be classified from their formation phase or from their industry sector. In the former, they are classified into:

  • Value Stocks: These are companies that have a good growth potential but those that are currently undervalued compared to their intrinsic value. They could be undervalued because of temporary problems like weak financial performance. Because it takes time before the value returns, these stocks are bought for the long term. A good example of value stocks is IBM and Cisco.

  • Growth Stocks: These are companies that are seeing a greater rate of growth than their industry peers. Most growth stocks are mostly technology companies like Google and Amazon that are seeing improved performance. These companies are known to make losses as the management invest in growth.

  • Income Stocks: These are large companies that investors don’t expect to continue growing as fast. Instead, they are known for the dividends they offer the investors. Some of these companies are Coca-Cola, General Motors, Home Depot, and Walmart.

  • Blue Chip Stocks: These are large companies that are well-known. Blue chip companies include companies like Apple, Intel, Goldman Sachs, and Visa.

  • Penny Stocks: These are small companies that are known to be highly volatile. They are called penny stocks because they tend to trade at below $10. These ones are known for people who have a high-risk appetite.

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Stocks can also be classified according to their industry. This classification includes: technology (Google and Facebook), financial (Goldman Sachs and Morgan Stanley), Transport (United Airlines and Delta), Utilities (Dominion Energy and Vectren Corp), Industrial (DowDuPont and BASF), Energy (Chevron and ExxonMobil), and Telecommunication (T-Mobile and AT&T) among others.

What moves stocks

After understanding the types of investors and the types of stocks that exist, it is now important to understand what moves stocks. Doing this will help you know when to initiate an investment and when to exit. Some of the factors that move stocks are:

  • Industry Performance: At times, stocks move in line with the trend in the underlying industry. For example, in the 2008 financial crisis, finance stocks dropped sharply after the bankruptcy of Lehman Brothers. In recent years, technology companies have moved up as investors search for the next big breakthrough companies like Google and Facebook.

  • Earnings: At the end of every quarter, companies release the performance of the quarter. In this, they release their revenues, earnings, and then issue guidance of the next quarter. A company that releases a disappointing quarter and a weak guidance sees its stock decline. On the other hand, a company that releases a bad quarter but raises guidance sees its stock move up.

  • Performance data: Investors pay close attention to key performance data of the companies they invest in. For example, when companies like Netflix and Facebook releases strong user growth, the stock tends to go up.

  • News: News is very important in determining the performance of a company’s stock. For example, if a popular CEO of a company resigns suddenly, the stock will likely move down. On the other hand, if a company hires a popular CEO, the stock will likely move up. Other news that moves markets includes mergers and acquisitions, a hack, and economic data.

What to look at when investing in a company

When you are considering the companies to invest in, you should consider a few factors which include:

  • The industry of the company. If you love technology companies, you should invest in tech companies and not utilities or industrials.

  • The valuation: If you want to invest in a company for a long-term, you should consider its valuation. Ideally, you want to invest in an undervalued company. To determine whether a company is undervalued, you should consider factors like the price-to-earnings multiple, the price-to-cash flow, the growth of the company, and other complex valuation methods like the Discounted Cash Flow (DCF).

  • The management: Ideally, you should invest in companies with excellent management teams. Most importantly, you should consider companies where the management owns shares in them.

  • Rewards: Companies reward shareholders by either issuing dividends or by buying back their own stocks. For growth companies, you should consider companies that have a track record of rewarding their shareholders.

  • Growth: It is important to invest in companies that are seeing growth in terms of revenue, earnings, margins, and cash flow.

  • Financial stability: You should consider a company that is not highly leveraged.

How to buy stocks

The easiest way to invest in stocks is to create a brokerage account and then buy the stock after doing your research.

Another easy way is to buy a stock’s CFD especially when you want to invest in international stocks. A Contract for Difference, or CFD, is offered by companies like OctaFx to enable global investors to invest in the stocks. By buying the CFD, you don’t own a part of the company but you will benefit when the price moves up.

Instead of buying a single stock, you can buy an index. An index is a basket of stocks that are created by index providers. They are used to show the overall movement of a certain number of stocks that have a similar characteristic. For example, the DAX is a selection of 30 of the biggest companies in Germany while Nasdaq is a selection of the biggest technology companies in the USA.

Here are just some of the advantages in buying index CFDs include:

  • With an index, you spread risk. If one company in the index goes down, the other companies can help maintain the index’ level

  • You can go both long or short an index depending on whether you think the price will go up or down

  • You can easily apply fundamental and technical analysis to CFD trading to help you identify entry and exit points

  • You have access to higher leverage which allows you to invest smaller amounts of your own funds. Though with higher leverage comes higher risks as well as rewards.

  • Commissions are lower in CFD trading than in stock trading

Important points to remember when investing in stocks

When investing in stocks, there are a number of important points you need to remember. These will help you make better decisions and avoid common mistakes. Some of them are:

  • It is important to protect your investments by using a stop loss.

  • While leverage is important, you should avoid being overleveraged.

  • It is acceptable to make mistakes in the stock market.

  • Always invest in companies you understand well.

  • Always have reasons for investing in a company.

  • Always invest a small part of your account in a particular stock.

Final thoughts on stock investments

Whether you are buying physical stocks or investing in the stock market through contracts for difference, you can make some very decent returns. However, do learn from examples like Bill Ackman who lost more than $4 billion when his investment in Valeant Pharmaceuticals tanked. He also lost more than $1 billion when his short on Herbalife failed. You can’t always avoid mistakes or losses so be sure to never invest more than you can afford to lose. Do your homework, learn the basics, study the stocks you plan to invest in, stay up to date on market news and you should be able to avoid the mistakes he and other investors have made.