How Do Stocks Work to Make Money- All stocks are connected to the stock market. The stock market is a huge marketplace where you can invest in companies and projects that you believe in, but you need money to do that. So the first question would be: how to make money with stocks? You’ll need money to buy the stocks, and after buying at a certain price, you can hope that the value of these stocks goes up and you’ll make a profit. If you don’t know where to start and what to do, how can you make money from stocks? Or: How do I make money from stocks?
What is How Do Stocks Work and how does it make money? I hear these two questions a lot and the answers are quite simple. You can make money off How Do Stocks Work or we can make money from How Do Stocks Work. It all comes down to profits and losses which means you need to know what stocks do. So, let’s get started by taking a look stock trading and how do stocks work in general before we dig into the specifics about How Do Stocks Work making money in the markets.
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What Are Three Ways to Make Money in the Stock Market?
Three ways to make money in the stock market are:
Sell stock shares at a profit—that is, for a higher price than you paid for them. This is the classic strategy, “buy low, sell high.”
Short-selling—This strategy is a reverse of the classic one above; it might be dubbed “sell high, buy low.” When you sell short, you borrow shares of stock (usually from a broker), sell them on the open market, and then buy them back later—if and when the price drops. Returning the shares to the lender, you pocket the profit. Short-selling is a bet that a stock will decline in value.
Collecting dividends—Many stocks pay dividends, a distribution of the company’s profits per share. Typically issued each quarter, they’re an extra reward for shareholders, usually paid in cash but sometimes in additional shares of stock.
Buy and Hold
There’s a common saying among long-term investors: “Time in the market beats timing the market.”
What does that mean? In short, one common way to make money in stocks is by adopting a buy-and-hold strategy, where you hold stocks or other securities for a long time instead of engaging in frequent buying and selling (a.k.a. trading).
That’s important because investors who consistently trade in and out of the market on a daily, weekly or monthly basis tend to miss out on opportunities for strong annual returns. Don’t believe it?
Consider this: The stock market returned 9.9% annually to those who remained fully invested during the 15 years through 2017, according to Putnam Investments. But, if you went in and out of the market, you jeopardized your chances of seeing those returns.
- For investors who missed just the 10 best days in that period, their annual return was only 5%.
- The annual return was just 2% for those who missed the 20 best days.
- Missing the 30 best days actually resulted in an average loss of -0.4% annually.
Clearly, being out of the market on its best days translates to vastly lower returns. While it might seem like the easy solution is simply to always make sure you’re invested on those days, it’s impossible to predict when they will be, and days of strong performance sometimes follow days of large dips.
That means you have to stay invested for the long haul to make sure you capture the stock market at its best. Adopting a buy and hold strategy can help you achieve this goal. (And, what’s more, it helps you come tax time by qualifying you for lower capital gains taxes.)
Opt for Funds Over Individual Stocks
Seasoned investors know that a time-tested investing practice called diversification is key to reducing risk and potentially boosting returns over time. Think of it as the investing equivalent of not putting all of your eggs in one basket.
Although most investors gravitate toward two investment types—individual stocks or stock funds, such as mutual funds or exchange-traded funds (ETF)—experts typically recommend the latter to maximize your diversification.
While you can buy an array of individual stocks to emulate the diversification you find automatically in funds, it can take time, a fair amount of investing savvy and a sizable cash commitment to do that successfully. An individual share of a single stock, for instance, can cost hundreds of dollars.
Funds, on the other hand, let you buy exposure to hundreds (or thousands) of individual investments with a single share. While everyone wants to throw all of their money into the next Apple (AAPL) or Tesla (TSLA), the simple fact is that most investors, including the professionals, don’t have a strong track record of predicting which companies will deliver outsize returns.
That’s why experts recommend most people invest in funds that passively track major indexes, like the S&P 500 or Nasdaq. This positions you to benefit from the approximate 10% average annual returns of the stock market as easily (and cheaply) as possible.
Reinvest Your Dividends
Many businesses pay their shareholders a dividend—a periodic payment based on their earnings.
While the small amounts you get paid in dividends may seem negligible, especially when you first start investing, they’re responsible for a large portion of the stock market’s historic growth. From September 1921 through September 2021, the S&P 500 saw average annual returns of 6.7%. When dividends were reinvested, however, that percentage jumped to almost 11%! That’s because each dividend you reinvest buys you more shares, which helps your earnings compound even faster.
That enhanced compounding is why many financial advisors recommend long-term investors reinvest their dividends rather than spending them when they receive the payments. Most brokerage companies give you the option to reinvest your dividend automatically by signing up for a dividend reinvestment program, or DRIP.
How Do You Take Profits From Stocks?
The ultimate aim of every investor is to make a profit from their stocks, of course. But knowing when to actually cash out and take that profit, locking in gains, is a key question, and there’s no one right answer. Much depends on an investor’s risk tolerance and time horizon—that is, how long they can afford to wait for the stock to earn, vis-a-vis how much profit they want to earn.
Don’t be greedy. Some financial pros recommend taking a profit after a stock has appreciated around 20% to 25% in price—even if it still seems to be rising. “The secret is to hop off the elevator on one of the floors on the way up and not ride it back down again,” as Investor’s Business Daily founder William O’Neil put it.9
Other advisors use a more complex rule of thumb, involving gradual profit-taking. Jeffrey Hirsch, chief market strategist at Probabilities Fund Management and editor-in-chief of The Stock Market Almanac, for example, has an “up 40%, sell 20%” strategy: When a stock goes up by 40%, sell 20% of the position; when it goes up another 40%, sell another 20%, and so on.
How To Make Money in the Stock Market
The best way to make money in the stock market isn’t with frequent buying and selling, but with a strategy known as “buying and holding.” This strategy was popularized by the father of value investing, Benjamin Graham, and is used by high-profile, successful investors like Warren Buffett
As an investor in common stocks, you need to focus on total return and make a decision to invest for the long term. This means that you:
- Select well-run companies with strong finances and a history of shareholder-friendly management practices.
- Hold each new position for a minimum of five years.
If you have chosen strong, well-run companies, the value of your stock will increase over time. As an example, you can view four popular stocks below to see how their prices increased over five years.
Conclusion
There are a lot of guides in cyberspace about how to make money from stocks, but most of them contain a mix of myths, rumors and plain lies. In this guide you will receive only the truth. Remember – investing in the stock market is not gambling. Do your homework and make sure you understand thoroughly what you are investing in.