In this article, I have explained basic stock trading strategies and terms for beginners. I have captured my investing experiences in this article, which I can assure you are worth over thousands of dollars, but before I go over this play book. I would like to warn you that if you’re an emotional or impulsive investor then please avoid this game. It is easy for a new investor to fall prey to failed investment made with a gut feeling or worthless market tips.
Definition of “Stock Market”
The market is in which shares are traded or issued through exchanges or over-the-counter (OTC) for companies. Investors can buy/sell stocks of companies listed on these exchanges. Exchanges allow companies to raise funds from investors like you and I by selling a slice of company share to us (called stock)
Major US Stock Exchange
New York Stock Exchange (NYSE): This is the premier listing venue for leading large and medium-sized companies. Companies like Best Buy and Target call the NYSE their home.
NASDAQ: This is the second largest exchange in the world by market capitalization and trade value. NASDAQ is the home of tech giants like Microsoft, Intel and Oracle.
American Stock Exchange (AMEX): This is the third largest stock exchange in the US and deals with small-cap stocks
Over The Counter Bulletin Board: This is not an exchange but act as a sub-section of other exchanges. Companies that do not meet NASDAQ or NYSE listing requirements are considered OTC stocks or penny stocks. Risk can be high in these stocks due to lack of regulation in this market.
NYSE and NASDAQ are regulated exchanges, which mean companies listed under these exchanges are subject to certain requirements, restrictions and guidelines for consumer protection and financial stability in the market. In simple words, companies listed on these exchanges are more transparent to investors. They publish financial reports and ad-hoc notifications on a regular basis. These notifications and reports allow investors to assess company performance.
Now let’s understand few market watchwords before we deep dive in the money pool
“Bull”/” Bear” Market
These phrases come from animal attacking techniques. For example: Bull thrust its thorns up in the air and Bear will swipes its paw down. These actions symbolize market trend for investors so if the market is going up, it’s a “Bull” market and if it is going down, it’s a “Bear” market.
These phrases are used to describe projected investment trends (long -up/short -down)
These are used to show benefit in any given situation (upside -lot/downside-no)
This is a payment made by the company for the stocks that you hold. This is a portion of the profit shared by the company with their shareholders
There are two types of investments – Direct and Indirect investment. In this article, I will focus only on “Direct” investment but I will share a bird’s eye view for “Indirect” investment
Direct Investment: Investment made by you or your broker to buy stocks, or equities are called direct investment
Indirect Investment: Investment made by you or your broker to buy mutual fund (open end fund) is called indirect investment. As I promised, let’s see why we call it indirect investment.
A mutual fund is a bundle of stocks from different companies. These funds are based on specific investment strategy designed by professionals. The fund strategy could be anything like sector, country, and large or small-cap stocks. The primary advantage of mutual fund is that you can invest without experience. This is known as indirect investment as you don’t invest directly in company stock.
This is the first step in this moneymaking business, to have a stock trading account. There are a lot of options available for online brokerage account, but the selection process to choose a best online brokerage firm could be little tricky. As per my experience, just compare below mentioned points for each online brokerage firm before opening an account.
Fees and Commission: This is an important structure of this process. Trade commission charged by brokerage firm can vary from $2 to $10 per online trade. Yes, you read it right per “online trade” which means you would pay $10 for buying and $10 for selling your stock online (charges for trade over the phone are higher). I know, you are here to bring in money so it is important to limit your expenses in trading (penny saved is penny earned).
Investment Offered: This is a vital component in trading business. Few brokerage firms don’t permit penny stock and international stock trading so I would recommend always verify with brokerage firm before opening an account.
Investment Tools: This is the key to success in trading business. You should always check tools offered by brokerage firm like real-time quote streaming, alert and advanced chart/graph features, this will help you to assess stock performance and form an appropriate decision at the right time. I’m sure you have understood this by now that this game is all about “right decision at right time.”
Deposit Requirement: This depends on your appetite so investor with significant funds to deposit can take advantage of various promotions, special offers and incentives offered by brokerage firms.
I know you have waited to read this section for quite some time now, but before you read trading strategy, let me share an example, which is based on a similar concept.
Example: What all elements, will you consider before buying an investment property (house/land)?
My guess …
1. Price Comparison (Cost comparison of investment house/land in same block)
2. Growth Potential (Appreciation of property value)
3. Income Potential (Expected rent from property)
These are exactly three points that you should analyze and watch out in a company before investing in a stock. Let me explain these three points in an analytical way.
1. Stock Price:
Stock price change every second per available supply and demand so keep close eye on your prey. Below mentioned are two basic formulas that you can use for stock price calculation.
a) P/E ratio: price of stock/ EPS (last 12 months)
This is one of the popular calculation methods in the market, which gives an estimate about the price paid by investor compared to earnings per share. High P/E suggest the company is expecting higher earnings growth in the future compared to companies with a lower P/E ratio
Example: Stock is trading at $10 per share, with $1 earnings per share, the P/E ratio for the stock would be 10 ($10/$1)
b) P/S ratio: stock price/ sales per share
This formula will show us a ratio for price paid by investor compared to sales per share. This can be used for companies with unpredictable earning patterns, but it is useful only to compare companies in the same industry as profit margins may vary from industry to industry, which can impact overall comparison of P/S ratio.
2. Growth Rate:
PEG ratio: (P/E ratio) / annual EPS growth
This method is used to calculate stock value considering the growth rate of the company. There are two types of PEG ratio calculations:
1) Forward PEG: PEG ratio based on projected earnings growth rate
2) Trailing PEG: PEG ratio based on historical earnings growth rate
This ratio indicates over and under priced stocks by including growth rate in the mix. The thumb rule is PEG ratio below one is appropriate for investment.
3. Dividend Yield: dividend per share/ stock price
Companies with high and predictable dividend yield are blue-chip companies (mature) so the chances of growth are less (this is my experience)
In my opinion, you might have understood the basic trading concept by now. In short, there are two possible ways to make money in stock market 1) Dividend payout and 2) Speculation (capital gain due to increase in stock price)
Bottom Line: Old adage worth mentioning here: “What’s obvious is obviously wrong.” Successful investing takes hard work and patience. Investors who do their homework before investing are the ones that succeed in this arena…Best of Luck!
Disclosure: I wrote this article myself with an intention to offer information to interested parties. It expresses my own opinions and experience so please do your own due diligence before investing in stocks.