News channels, magazines, movies, and the entire media assume that you know your way around stocks. Furthermore, stocks have been talked about so much that you also began assuming that you know how it works.
If you really know your stuff, then that’s good because investing in stocks has great returns. However, most beginners may lack the know-how to enjoy profits from stock market investing. So, first things first – what are stocks? How does the stock market work?
Stock and Stock Market
Stock, also called equity, is a form of security representing partial ownership of a company’s total shares. The holder has a proportional claim to the company’s returns, depending on the company’s aggregate profit.
You can say that you have a “share” of the company if you own several stock units. Having a company share makes you a shareholder of that company. For example, if a company has 4,000 outstanding shares, and you buy 1000 shares, you own 25% of that particular company’s share.
Note that a shareholder/stockholder owns 100% of their respective shares, but not the company assets. Thus, a shareholder has no legal right to walk out of the company with a chair. While you may have control over how the business operates, you have no control over the company’s assets. Economics dubbed it “separation of ownership and control.”
The idea of stock investment came from the need for companies to fund their operations while minimizing operational risks. In return, the investors earn dividends from the profits the companies make.
Stocks can be categorized into two: preferred and common stocks. The holders of preferred stock are issued a certain proportion of dividends before other investors. On the other hand, the common stockholders have voting rights in company decision-making.
Stock is bought from stock exchanges like the Nairobi Securities Exchange (NSE). You can consider the stock market to be an after-market and stock exchanges to be its subset. Thus, the stock market can be defined as the collection of equities/stocks sold and bought in various stock exchanges by the public.
Investing in Stocks
Investing is quite different from trading, in that investing is a long-term approach to getting returns from the market. Traders, on the other hand, leverage the fall and rise of the stock market.
Thus, investors buy and hold stocks for huge profits while traders may enter or exit positions for smaller, frequent profits within a short period.
The objective of investing is to generate steady wealth in the long term, by purchasing and holding stocks, mutual funds, and bonds, and developing their stocks’ portfolio, among other financial investment instruments.
Hence, your primary reason for investing in stocks should be to make profits while participating in the company’s long-term success.
In a nutshell, investing is setting aside funds to work for you while you are busy intending to reaping profits in the future.
So if you have bought a stock before and held it for the long term, then you are an investor. Otherwise, if you have bought and sold when the stock price hit your target, then you are a trader.
Stock Investing Cheat Sheet for Dummies
The stock market is an unpredictable and risky venture. You have probably heard the news pundits dubbing phrases like: “Safaricom stock shares have skyrocketed.” But that’s not always the case.
Most traders make money from the rise and fall of stocks, while some lose. How do you succeed in the stock market as a beginner?
Stock Investing Guide for Dummies
Below are some tips on how to survive in the stock market:
- Purchase the right investment instrument
Easier said than done. Finding the right stock to buy can be a daunting experience for some. Determining stocks based on their past performance is simple, but their future performance is purely speculative.
To succeed in the stock market, investors have to do intensive research on the company. For instance, you need fundamental analysis skills. Thus, consider financial measures like price-to-earnings ratio (P/E) or earnings per share (EPS), price-to-sales ratio (PSR), return on equity (ROE), debt-to-asset ratio, and earnings growth.
However, the financial ratios are not enough. You will need to do background checks on the corporation’s management team, the company’s competitive edge, and its financials (especially the income statement and balance sheet). The bottom line is that you shouldn’t put your faith in the company’s past performance for future results.
- Keep away from individual stocks
Avoid having unrealistic expectations from a single stock. A stock may perform well for a while, but you have to anticipate downturns. Additionally, don’t confuse first-time luck when choosing a stock with skills because you will eventually run out of luck.
To make a fortune out of an individual stock, you will need more than luck. For instance, you can get huge returns if you know something about the stock that isn’t priced at the moment.
However, there is a way out. You can invest in an index fund– ETFs and mutual funds, which hold a number of stocks. Hence, when you purchase a share of an index fund, you basically buy stocks from hundreds of companies in the index.
- Diversify your portfolio
An important rule of the trade is, “do not put all your eggs in one basket.” Ensure that you diversify your portfolio with various stocks. Diversification is essential, since when one falls, the others make up for the loss. Thus, your overall performance and returns are not hurt by a single stock.
An easy way of diversifying your portfolio is investing in index funds, especially when you don’t know which stocks to choose. However, do not confuse diversification with buying different stocks only. It can also include investing in various asset classes.
- Stay vigilant, the bear is coming
Always stay ready for a market downturn. The bear market, when the stock market gradually declines and the prices stay down for some time, is inevitable. And when it comes, you will incur losses since your stock value has declined.
Most investors panic and sell during a bear market. This will be like buying high and selling low. Thus, you need to be ready for market downturns. A savvy investor grows the skin of steel to withstand the occasional short-term volatility to enjoy long-term yields.
Furthermore, you should keep in mind that stocks do not guarantee returns. It is possible that you may lose your funds when the company becomes insolvent.
- Practice before putting your money in stocks
Technology has made it simple to enter the stock market without incurring risks. Novice traders can use simulators to practice, with virtual money, before they can invest with real money.
Simulators help you pick the stocks you would like to invest in and see how they would perform if you put your money in them. Practice makes perfect (not exactly, but nearly).
- Do your own research (DYOR)
Do not invest based on social media buzz or peer pressure. It is always important to do your research on the stocks you intend to buy and hold. You can find information about stocks and listed companies from Nairobi Securities Exchange (NSE), Capital Markets Authority (CMA), Yahoo Finance, etc.
However, you are not limited to Kenyan stocks only. You can also explore global stock markets via online exchange brokers, like Scope Market.
- Have a goal and stick to it
Why are you investing? Is it because all your friends own stocks? Are you hearing the same message from everyone around you, that you should invest before it’s too late?
If you are investing for the wrong reasons, then get out as soon as possible. Having a clear objective on why you are investing can help you steer in the right direction and help you yield good returns. It can also help you in choosing the right stock to invest your money in.
In addition, you should invest with the mindset of long-term returns. Thus, as a beginner, avoid the daily buzz from social media and news channels to keep your emotions in check. Instead, have a calendar on when you will be assessing your portfolio. Remember to stick to the plan.
- Start now
The right time to start something is now. The same applies to investing. It is never too early to invest in stocks. There is nothing like the perfect timing in making investments. Stop thinking about it and do it.
- Invest what you can stomach to lose
An essential tip to keep in mind is to always start small. You don’t want to lose all your life’s savings when things don’t turn out as you had speculated. Hence, invest only what you can afford to lose.
Stock Market for Dummies Summary
As a beginner, you might be excited that you are now the boss of a company because you own more than 50% of the company stocks. But that is not the case. Most companies acquire loans with their assets as collateral, meaning that in the event of insolvency, the bank or investors have the legal right to seize control of the assets and the property.
In addition, the stockholder does not necessarily get discounts when buying from the company. The ownership of a stock only makes you legible for the company’s profits. Thus, as a potential stockholder, you should dispel the common misconceptions about stock ownership powers to enjoy the long-term benefits.