Talk of investing, and the first thing to pop up in mind is stocks. But does this mean that stocks are the ultimate roadmap to financial freedom? A stock is an investment asset giving partial company ownership to the owner, security that shows the holder has a stake in the issuing organization.
Corporations issue shares in exchange for finances for expansion and development programs. In return to owning stocks, a stock investor gets returns in the form of dividends, shared profits, and a voice on how to run the affairs of that corporation.
Why invest in stocks?
Investors are interested in the stock market due to the inherent potential of stocks to appreciate. This is not to say that all stock investment will turn a tidy profit. However, stock investing is all about buying stocks cheaply and selling them at a higher value. Therefore, investors have to buy and sell stocks through the stock exchange to be a part of this highly dynamic and profitable market.
Except for start-ups floating penny stocks, publicly-traded organizations putting up stock for sale fall under the SEC’s stock exchange regulatory authority. The SEC regulates organizations in the stock market to ensure investors don’t fall prey to fraudulent activities.
How to be part of the stock market
There are two ways of being part of the stock market:
- Investing in stocks: taking ownership of corporation shares and enjoying dividends as returns on investment.
- Trading in stocks through ETFs and CFDs: ETFs refers to a fund that combines several stocks into one basket and tracks a particular index. CFDs trading involves active trading in a contract of a price difference, speculation on the movement of stock prices without taking ownership.
Both stock trading and investing involves a simple three-step process
What would be your profit if ten years ago you had invested $500 in Tesla, Amazon, and Facebook class A?
- If you had invested in Tesla stocks at the initial IPO of $17, an investment of $500 would be worth $19733, not factoring in dividend payouts.
- If you had invested in Amazon, the share price was $134; the same $500 investment would now be worth $12164.
- If you had invested in Facebook class A when the share price was $9.82, a $500 investment would now be worth $16000.
But is everything so smooth with stock investing, or are there any risks?
Stock trading risks
Despite the popularity of stock investing and potential returns, investors taking part in the stock market have to be wary of three significant risks:
The volatility refers to momentary changes in price. Stocks that experience massive price rallies and high volatility are high-risk investment assets, while those exhibiting steady, consistent movements are more stable assets. Stock volatility results from actual events affecting a particular stock difference between the expected and the substantial drives volatility. Events with the most impact on stock volatility include; geopolitical events, inflation, economic events such as interest rates, and investor interest and speculation.
The stock market moves in seconds, validating the saying, “Time is money.” Knowing when to invest as well as when to get out of the market. The trick in stock investing is buying low and selling high. However, this is not clear as day and night; otherwise, everyone would be a successful stock trader. Experts agree that timing the market is next to impossible. The only way to deal with timing risk is to have an investment objective in the long term.
In the stock markets, fear and greed and the most significant loss factors. Emotions have no place in the markets. Overconfidence results in investment mistakes:
- Leverage overuse
It allows investors to trade in more stocks than their funds allow. However, too high a leverage results in investment wipe out when markets go against an active position.
Overconfidence creates biases to particular stocks, especially regular winners, blinding investors to any potential pitfalls of these stocks. As a result, biased market decisions are predominantly losing positions.
- Aggressive timing
Timing the market is very alluring; however, market variables are too many to predict the next profitable move in the short term accurately. The trick is inconsistent profits over a long time rather than get rich quick, short-term strategies.
The beauty of the stock market and the brokers is that they offer demo accounts. Demo accounts mimic the market to a tee without investors putting real money on the line. It is a platform that allows investors to observe how the stock market works by providing historical as well as real-time data on the stock market price movements. Investors get a chance to test and perfect their trading strategies and money management rules before investing with real money.
Stock market research
There are two approaches to stock investing and designing a trading strategy, fundamental and technical analysis.
Fundamental analysis in the stock market involves analysis of the economic well-being of a corporation and the country as a whole. All variables impacting the value of stocks are put into consideration with close monitoring. Close monitoring of these variables informs investors on potential market reactions facilitating counter-strategies to mitigate against loss.
For example, the current legalization of Marijuana across several states in the US has seen the value of marijuana stocks rise.
Technical analysis is all about pattern recognition on dynamic price charts. Investors analyze stock price patterns to identify the cyclical, repetitive market movement to inform when to enter and exit the markets.
For example, investors and traders alike are always looking for prices concerning the 200-day moving average. As a result, prices are actively trading above the indicator hint at a bullish market, while active trading below signals a bearish market.
All successful investors subscribe to a religiously followed routine. The routine informs what to buy, how much to buy, and when to exit trades. Of course, there is no standard investing routine, but it should be tailor-made to suit individual objectives and investing styles.
However, all investing routine should:
- Check the current market trend with the ultimate long-term investment objective in mind.
- Analyze the market to identify the best stocks for investment.
- Evaluate the market to determine the perfect entry and exit to the stock markets.
Stock fluctuations surprises
As a stock investor and trader, not all positions are profitable. A diversified portfolio ensures that the overall portfolio does not take a hit in loss on one stock held; instead of holding a single stock, investors partly put money in ETFs, mutual funds, and government bonds. While trading, the use of stop-loss mitigates against both expected and unexpected price fluctuations.
For both trading and investing, the use of hedged positions mitigates stock price fluctuations. Hedging involves creating a counter position or investment to protect against losses due to unexpected price movements.
Stocks provide investors with an avenue to be part of public traded companies and enjoy returns on their investments in the form of dividends. They are also excellent investment instruments for wealth creation if picked correctly. They also offer investors tax breaks as dividend taxation is lower than interest income from other investments.
All investments exhibit an element of risk, more so in stocks. However, with the right stocks and close monitoring of stock market risks, they provide huge return potential.