Learning how to invest in stocks is a question that many people are asking these days. It is indeed an important question because everyone has a desire to put their capital to work for them. The wealthiest people on the planet have proven to us that true wealth is achieved by letting our money work for us instead of the other way around.
A big reason that this is true is simply because we only have a finite number of hours to work, so thus, our potential for wealth from our own labour is very limited. When our money works for us, then as it earns more money, then the new earnings can work for us as well – and so on and so on. We all know that this is called compounding.
One of the arenas that these wealthy people have earned their fortune is in the stock market. They find good stocks to invest in and then watch stock market quotes to see how their portfolio is doing overall. However, many of them simply pay someone to watch the Dow stock market for them.
Most of us do not have such a luxury, so we have to learn how to invest in stocks ourselves, and then make the buying and selling decisions on our own. This is not a bad thing; we just have to learn a few investing rules to keep us out of trouble. When we use a few solid methods that have proven to be reliable over and over again across many years, then we can expect nice results.
The First Step In Finding Hot Stocks
If you have ever check out the stock market, then you already know that there are many “stock indexes” which are simply groups of stocks that are a collection representing a category or a sector. The performance of these stock indexes during a stock trading day is a net result of how all the individual stocks within that group are performing. As you follow how these indexes or sectors during a market hours, it give you an idea of how the overall markets are doing.
The index performance has an enormous psychological effect on stock investors. When the Dow Jones Industrial average is in a deep decline, you can pretty much guess that most stocks are being sold and there may be some panic in the overall markets. When the Dow is going up dramatically, there is lots of buying and there is a bit of euphoria present.
If we look closer at these groupings of stocks, we will see sectors such as: energy, financials, health care, and so forth. In most cases, stocks in these sectors all perform in a similar fashion. And if a big member of one of those sectors (such as Microsoft in “technology”) reports strong earnings for a given quarter, then usually EVERY stock in that sector goes up. This is why you have to be aware of how sectors are doing in the stock markets. The first step is finding a sector that is hot in the markets.
Locate Good Stocks From Good Sectors
Okay. Now that you have found a few sectors that seem healthy and are performing well in the markets, then you need to start focusing in on some of the more desirable stocks within those sectors.
It should be mentioned here that not every stock will be doing well in a great sector. Often times, a certain company or two will have their own problems that are unique to them and not the overall sector. For instance, maybe there was some corruption discovered within company, or maybe their CEO made some poor decisions, or perhaps there is a pending merger.
The first thing you should be looking at regarding a prospective company is their earnings. I personally like to see at least 8 quarters of positive earnings. In addition to that, I like to at least the last 4 quarter showing a gradual increase in earnings.
An Important Key In How To Invest In Stocks
One thing you have to be careful about is whether or not a healthy stock has run its course. To go a step further, you should also consider whether or not a stock sector has run its course. You don’t want to get to the party too late – otherwise, those already holding the stock will be taking your money as profit.
So how can you tell if the stock has run its course? Look at the stock price chart. How long has it been on a roll? If it’s been a year or so, then you may want to reconsider.
Another great stock indicator is the P/E ratio (or the price to earnings ratio). This indicator tells you how inflated the stock price is. There are no specific P/E ratio levels that tell you when to buy or sell because you will find that certain sectors have higher numbers than others.
For instance, tech stocks in the late 1990s had P/E ratios of 400 or more. On the other, I have heard conservative investors say they will not buy a stock with a P/E of greater than 40.
Here’s the important thing about P/E ratios. When the ratio is lower, then there is more potential for that stock to grow in the future. If the number is high, then the stock will not grow as much, BUT more buyers are usually buying it – that’s why the number is high.
The second important thing about P/E ratios is that stocks with high ratios tend to drop faster and drop lower than stocks with lower P/E ratios. This indicates that lower P/E ratio stocks are much safer because the price is not as inflated.
So as you evaluate the stocks in your chosen sectors, you need to put together a list of 4 or 5 stocks to watch.
Planning Your Stock Market Entry
So now you have found your preferred market sectors, and within that sector, you have found a handful of stocks to put on your watch list. Now is the time to pull out the stock market charts for these stocks in order to get a feel for how the price has been moving.
You need to find the optimal time for making your purchase. What many new stock investors do not realize is that you can easily lose hundreds if not thousands of dollars from a bad entry into the market. This is why we pick 4 or 5 stocks to watch. Some of them will never give you an entry point; you are just looking for one that does.
The time to buy the stock is when the price has pulled back temporarily out of its rising trend, and has begun to resume its uptrend.
If you buy when it is trending, then you will instantly lose money on a sudden pullback. If you buy during the pullback, then you may have bought as it is going into a downtrend. So you need to buy when it resumes the upward trend – giving you some assurance that it’s still going up.
Another thing to think about here is that you must always have a stop price – meaning the level where you will sell to cut your losses. Many traders like to set their stop loss at 8-10% below where they bought the stock. If you mistakenly buy the stock as it’s going up, then when it pulls back, you could get “stopped out of your position” – meaning you took a 10% loss – and then the stock maybe took off again without you.
There’s a couple of ways to properly time you stock purchase. Here the most popular:
1 – You first wait for the price pull back and wait 2-3 days.
2 – Now put in an order to buy the stock when today’s price rises above yesterday’s high price.
The second way is by using an oscillator from a stock chart after the stock has pulled back. I am not going to cover oscillators here, but they are indicators to give you an idea of how a stock’s price is swinging back and forth. They basically help you time the purchase. You can find them on any stock chart website. I highly encourage you to at least check them out.
Managing Your Stock Positions
Now we’re getting to the real nitty gritty. You bought your stock, now you need to manage it effectively to either extract profits or to cut your losses. Professional stock investors will tell you that managing your stocks is the most important part of learning how to invest in stocks.
We already talked about having a stop loss level to minimize your losses. It is worth mentioning again. You should never buy a stock without first knowing where you will sell to cut your losses. In today’s online trading world, virtually every stock brokerage has a console that allows you to set your stop loss so that your stock is automatically sold when the price drops to your stop loss price.
Now you need to have a plan for taking profits. To begin with, it is a good idea to move your stop loss price up as the stock price goes up – this allows you to lock in a certain level of profits. This is known as a “trailing stop”. There are literally thousands of ways to do this.
If you want to take profits quickly, then your trailing stop should be tighter which protects your paper profits more completely. If you are looking for a bigger move with bigger profits, then your trailing stop should be much wider.
Keep in mind that tighter stops will often cause you to get prematurely stopped out of a position – only to watch the stock price soar without you. Therefore, you need to set your trailing stop very carefully.
One last technique that should be mentioned is the notion of selling off part of your position. A lot of stock traders like to take profits on a nice predetermined price increase by selling a portion of the position. They then let the rest of the stock position run by setting a looser trailing stop. It’s a technique that lets you have the best of both worlds. You take some early profits to help protect your account and then you still have a chance to take a big profit later.
Conclusion
As you can see, there are many ways to learn how to invest in stocks. This is why there are so many types of stock investors taking part in the stock market.
In addition, you will find that those who are intensely successful at investing in stocks all have completely different personalities and viewpoints regarding their stock investing strategies.
There are stock traders who buy just a few stocks every year and make millions, and there are those who buy hundreds of different stocks every single day and also make millions. As you might imagine, there are also those whose trading styles lie in between these two extremes.
Some investors watch only stock market charts and make determinations from the price action exclusively. Other investors read financial and global news, looking for investing opportunities based on external items like current events and management activities.
Knowing all this should be great news for anyone who wants to earn money in the stock markets. When it means is that the market will let you be yourself and as long as you use sound and solid investing principles – such as setting a stop loss – then there’s no reason why you can’t enjoy success in the stock markets. This is perhaps the most important thing to realize as you learn how to invest in stocks.