You can make money from stocks and related market products in a number of ways. But there are also lots of ways to lose money. And I’m going to tell you about all of that. Plus some tips to minimize the downside, assuming that might be your goal.
Basic ways to make money from stocks
Let’s say you have $1,000 to invest in the stock market. And you are open to exploring any number or ways that money could be put to work. What can you do with your money?
Your most traditional choice
- Buy stocks directly from a broker and hold them “long term”. (At least a year for this to be treated as capital gains on your taxes.) But you’ll want to hold much longer if you’re buying them for your investment “portfolio” (group of investments). Many people simply buy a diversified (and balanced) portfolio of stocks. Then they just let them sit there and grow (hopefully) without doing anything else.
Example: Let’s say you want 40 shares of XYZQ stock. It’s currently selling for $25 per share. (Note: The price can go up or down even on the same day, assuming the stock is actively traded.) And then you decide to sell many years from now, maybe as part of your retirement savings. If the stock is then $55, you will have made $1200. And if it happens to pay a dividend, you also made money along the way!
NOTE: You also need to make room for the commission / fee your broker charges for the trade. This can cost you as little as $5 per trade. On the other end, some brokers charge a pricey 3+ percent per trade or more. Although you shouldn’t pay that high, a 3% commission would mean that particular trade cost you another $30. I’d suggest you look for much less. But if you’re holding long term and really want that broker, you still might make money — just not as much.
A little more aggressive approach
- You can buy shares of stock with the intent to trade them, hopefully selling as soon as you’ve made some amount that feels good to you. The object in this case is to lock in a profit, and then turn that money over into a new stock that you believe has more growth potential in it than the one you just sold. A trader keeps doing this.
- And then there’s a blend of the first two. You buy quality stocks that you want to hang on to long term. But you can also use some percentage of your money to trade. Or, after some time, you can take some or all of your investment profit and use only that to trade. And when you do trade, you might even only sell enough to equal the trading profit each time. If you reinvest that, factoring in commissions, you can lock in profit and keep going.
Riskier ways to make money from stocks
- Although not something I’d advise beginners to do, one way to make money from stocks is to sell a stock short. This means you sell what you don’t yet own (borrowing against a future action). You are hoping to buy the stock at some future point, at a much lower price. An investor might do this if they feel strongly that the stock is headed downward.
Downside? The stock can keep going UP endlessly. And you’ll owe the difference from the price where you shorted to the price it now is. This is usually done without putting the full amount of cash down, so you assume added risk. At some point, you may receive notice to pay up part of the difference immediately.
For me, selling short is not worth the risk. But you should know that there are people short-trading — betting against the market or individual stocks — every day. This is one of the reasons why even in a down market people still make money from stocks.
The Las Vegas way to play with stocks
- You can also get involved with stock options (called “puts” betting downward and “calls” betting upward). This involves buying either what they call “naked” options (you don’t own the stock) or “covered” options (you do own the stock). Naked options are pretty much gambling (for a small premium) on the stock going in the direction you want. But you don’t have ownership of the stock to lessen your risk.
Covered options help minimize downward risk. But that can also limit your profit. Options you write on stock you own give some other unknown buyer a chance to buy your shares at a set “strike price”.
If all this sounds confusing, rest assured that it’s probably not a smart move for a beginner. I learned this the hard way many, many years ago. I watched in shock as my naked options went to zero (no value whatsoever) when they reached their expiration date.
Basic ways to NOT make money from stocks
Any or all of the above! If there were any one perfect formula, there would be no stock market. Instead you’d have a cornucopia of endless money you could always reach into whenever the urge strikes. (Wouldn’t THAT be nice.) The basic rule is that if you sell for less than you paid, you’ve lost money. BUT … even as markets are looking scary, you have not lost one penny if you haven’t sold yet. Sitting it out is often the wisest strategy.
And let’s not forget about NOT putting all your stock eggs in one basket. Or not buying everything all at one time if you have a lump sum to invest. Markets move up and down, so taking a lump sum and investing it in regular amounts over a period of time (similar to the way you do retirement savings) can help. This way you average out the price you pay. (Dollar cost averaging.)
As for that basket of stocks … even a stock you love and are absolutely sure of can at any point tank (head south). And this happens for all kinds of reasons, known and unknown, often to the surprise of the owner. And many recognized experts.
Portfolio theory tells us to spread the risk with a mix of balanced investments. Although a single high-quality stock may stay around for a long time, a mix of high-quality stocks is much more likely to keep your investments safe.
A few more thoughts
As I’ve said elsewhere, making money from buying and selling stocks is not guaranteed. But owning a good mix of stocks and other market investments (balance is key) is a smart way to go. This gives your money the best chance for long-term growth potential, if the last 100+ years is any indication. (Again, no guarantee.)
So if you’re a beginner who is looking to make money from stocks, stick to the basics. Unless you have money to burn, look for quality stocks you wouldn’t mind getting stuck with for the long term. As for the best way to protect yourself from any one stock tanking and wiping you out? Own a good quality, well-balanced mix of stocks (sector/business, company size, country of origin, growth/income, etc.)
You can’t control the highs and lows of the stock market. But if you carefully select a well-diversified mix of stocks (not too much money in any one), you should be ok. And over time, if you’re patient and check in now and then for clunkers, you should see your money grow nicely.
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