There are quite a few ways to make money from stocks and related market products, and I’m going to talk about that. But there are also lots of ways to lose money — and I’m going to tell you about that also. 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?
- You can 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 probably much longer if you are buying it for the precise goal of holding it in your investment “portfolio” (group of investments) for it to be able to grow without you doing anything more to it.
Example: If you want some XYZQ stock, which is selling for $25 per share at present (price can go up or down from that point as shares are being bought and sold during the day by other people or organizations), you can buy 40 shares. And when you finally 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. Not bad at all.
NOTE: You also need to make room for the commission / fee that your broker charges for the trade. This can range from as low as about $5 per trade all the way up to a very pricey 3+ percent per trade, as some brokers may choose to charge. Although you shouldn’t be paying that high, a 3% commission would mean that particular trade cost you another $30. I would suggest you look for much less, but if you’re holding long term and are determined to trade with that broker, then that probably won’t keep you from making money — just not as much.
- 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.
- You can also do a blend of the first two, buying quality stock you want to hang on to, but also with the intent to trade a smaller portion of your shares if it performs really well in the short term, and you want to buy a little of something else that looks tempting at this time. You might even only sell enough to equal the profit and reinvest that, factoring in commissions in and out. Again, this way you lock in some profit.
- Although this is not something I’d advise beginners to do, you can sell a stock “short,” which means you sell what you don’t yet own (borrowing against a future action), with the idea of buying it at some future point. An investor might want to do this if they feel strongly that the stock is headed downward. In effect, you are hoping for a much lower price at which to buy the actual amount of stock you shorted without yet actually owning it.
Downside? The stock can keep going UP endlessly, and you will owe the difference from the price where you shorted to the price it now is. Since this is usually done without putting the full amount of cash down, you can get badly burned by receiving notice to pay up part of the difference immediately. For me, this is not worth the risk. But figured I’d explain that some of this goes on every day. One of the reasons why even in a down market people are making money.
- You can get involved with stock options (called “puts” betting downward and “calls” betting upward), buying either what they call “naked” options (you don’t own the stock) or “covered” options (you already own the stock). Naked options are pretty much gambling (for a small premium) on the stock going in the direction you want, without the solid ownership of the stock to lessen your risk.
Covered options can be used to minimize downward risk, but also can somewhat limit your profit since the options you write on all or some of what you own give some unknown buyer a chance to purchase your shares at a set “strike price”. If all this sounds confusing, rest assured that it’s not for the beginner. Something I learned the hard way many, many years ago when I watched in shock as my naked options went to zero (no value whatsoever) as they reached their expiration date.
Basic ways to lose money with stocks
Any or all of the above! If there were any one perfect formula, we’d have no stock market. It would be called 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) might help 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) for any number of reasons, to the surprise of all the genius pundits and especially anyone who owns it. Portfolio theory tells us to spread the risk with a mix of balanced investments. (Although a single high-quality stock may be more likely to stay around, 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) can give your money the best chance for long-term money growth potential, if the last 100+ years is any indication. (Again, no guarantee.)
So if you’re a beginner, unless you have money to burn the same as you might at a roulette table, stick to buying and selling quality stocks you wouldn’t mind getting stuck with for the long term. And protect yourself from any one stock tanking by owning a good, well-balanced (sector/business, company size, country of origin, growth/income, etc.) mix.
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