Editor’s note: This article was first published in August 2011, during that summer’s market turmoil. Its references to today’s volatile market, online bank terms and 2011 Spanish retail banking reflect that moment; low-cost and zero-commission brokers have changed the picture since. Berkshire Hathaway later took large stakes in IBM and Apple.
Many people ask us about the basics of investing in the stock market. Some want to know where to go to buy shares in a listed company; others ask why a company that is making a profit has fallen on the stock market along with every other stock. That’s why this article focuses on the many people who want to get into investing but lack the basics.
While we’re at it, those of us who already invest could do with a refresher on a few concepts we may have forgotten, and you’re welcome to chip in if you notice I’ve left out a point that could matter to someone just starting out. Let’s begin.
We’ll assume that you have no idea how to invest in the stock market and don’t know exactly what the stock market is, so we’ll approach this as a sort of… course, let’s say. First of all, I think it’s worth getting to know the five types of markets you can invest in: Types of financial markets.
With that covered, let’s focus on the stock market.
Where can I buy shares in listed companies?
Some people think that when investing in the stock market they can skip the middleman, but that isn’t the case. An individual has to go through an asset manager or a bank (a broker), so you will have to pay a small commission both when you buy shares and when you sell them. To get started, the best thing is undoubtedly to go to your bank and discuss the terms with them (and always compare them with other banks’ terms). You’ll have heard that you need a broker to invest; well, in this case that broker is the bank. You also have the option of choosing an online broker.
These days, online banks offer very good terms for investing in the stock market. In short, you go to a bank and they’ll explain it to you. Without wanting to advertise any bank, some time ago we wrote about some interesting terms offered by Self Bank.
Note: As soon as the bank realizes you have no investing experience, it will probably try to steer you toward other kinds of products, such as investment funds (Be careful with investment funds), mixed deposits, “guaranteed” funds and so on. I sometimes talk to people who say they don’t invest in the stock market because years ago they did and lost all their money, and on top of that were being chased for a considerable debt. Clearly, those people didn’t invest in the stock market but in some other kind of product.
What’s the minimum to invest in the stock market?
This is another very common question, which we covered in an earlier article. There is no minimum for investing in the stock market, but you have to be smart about the minimum amount you invest so that you don’t lose money even when the investment itself went well. Read this article to clear up any doubts: What’s the minimum to invest in the stock market?
Which shares should I invest in?
Another frequent question from the “inexperienced”, though it’s even more frequent among active investors. Many factors influence whether a company’s share price goes up or down. Even experienced investors put their foot in it now and then, or quite often.
Someone who wants to buy shares and hold them for 10 years will need to analyze very different factors from someone planning to speculate on the stock in the short term.
The usual advice is to analyze the company’s management, since depending on who is at the helm, the company will inspire more or less confidence among other investors. That said, as we’ve mentioned before, a company’s management and successful plans aren’t everything when we want to invest over the short or medium term.
Some people think a company’s strategy, business plan, management and team have no influence at all on its share price. I personally disagree quite strongly with that view, because today there is no company with a high market value that has poor leadership (the two are incompatible). Still, it’s true that in the short and medium term it doesn’t matter how well a company is doing: if the market decides to fall, every stock can fall with it. If you decide to invest with a long-term view, then, as Warren Buffett rightly said, look for a company that has been in its industry for a long time and that, whatever happens, the odds say no other company will overtake. Look for a company that knows how to adapt to change and to new times. This article will give you an idea of what the best investor of our time looks for: Why doesn’t Warren Buffett invest in tech companies, but does in Coca-Cola? We have also published the portfolio that earns Buffett such strong returns: Warren Buffett’s investment portfolio.
See also: The most profitable investments of 2010–2011
Why do shares go up and down?
There are surely more complete explanations out there, but I’ll try to sum it up very simply. As we’ve explained on several occasions, share prices are driven by fear and greed. If you hold Telefónica shares and think they’re going to fall, you sell them so as not to lose money. By selling, you push the price down even further (obviously, we’re talking about large amounts).
In short, shares fall because investors get rid of them and rise because investors buy them. There’s no other explanation. That’s why sometimes the best investor isn’t an analyst but a psychologist who, depending on market conditions, can anticipate what thousands of investors are about to do.
In these two articles we explained investing in simple terms. You’ll find them very useful:
Are stock market simulators useful?
We also wrote an article about this, but it’s worth a reminder. Since we’re focusing on beginners here, a simulator may be a good idea, above all to learn how a trading platform works and how to use it. Just as when you learned to drive, it makes sense to practice on the simulator you’ll later use to invest, or at least on a similar platform.
As for whether simulators are useful for learning to invest… I have my doubts, and I explained why in this article: Is it useful to learn to invest with virtual money in a simulator? Remember that fear and greed (the key forces in the stock market) disappear when the money isn’t real.
The big question: which shares should I buy in the current market?
Before asking which shares to buy (not usually a beginner’s question, since it’s one we all ask ourselves all the time), you also need to consider when you’re going to buy and where the company (the stock) you’re going to invest in currently stands.
At this point, it’s highly advisable to study not only the company but also its price history on a chart, because a company on an upward trend isn’t always a better option than one that’s losing value. I think you’ll understand this part better with our article on the ball method of investing, a very effective method when you don’t plan to hold a stock for its dividends, that is, when you plan to speculate on it.
When investing for the long term, we also need to consider the dividend factor, since some companies may not rise much on the stock market, and may even fall, yet pay good dividends. Of course, for someone investing only €1,000 or €2,000, the dividends aren’t usually very striking.
So right now we could look at the investment strategies that big asset managers and “heavyweight investors” are using and try, as far as possible, to adapt them to our own capital and circumstances: 3 investment strategies for today’s volatile market.
Finally, to understand all this much better, suppose we buy some shares and the market starts to fall. What would you do? Sell, hold or buy more? Another article that will help you understand what to do in this kind of situation: Falling stocks: what should you do?
Further reading
Featured image: Iván Rivera, CC BY-SA 2.0, via Flickr.
