Many would-be investors are probably wondering - what is the stock market, what is stock trading and, finally, how do I invest in stocks? In this article, we answer all those questions and more.
In this article you will learn:
- Stocks as financial instruments
- What is the stock market?
- How to buy stocks
- Investing or trading?
- Fundamental vs technical analysis
Investing in stocks has gained in popularity in 2020 following the Covid-19 stock market crash. This should not come as a surprise – we live in a low interest rates environment as major central banks eased their monetary policy. This means that saving money through safe instruments (e.g. savings accounts or government bonds) has become extremely tough or, in many cases, impossible. Apart from that, top global brokerage firms have made stock trading simple, convenient and low-cost. Many would-be investors are probably wondering - what is the stock market, what is stock trading and, finally, how do I invest in stocks? In this article, we answer all those questions and more.
Stocks as financial instruments
Let us begin with the explanation of stocks, which is essential before making any stock market investment. Stocks (also known as equities) are securities that represent the ownership of a fraction of a company. You might also come across the term “shares”, which in theory is slightly different compared to “stocks”. Shares might refer to different kinds of investments, e.g. mutual funds, ETFs or privately held firms. On the other hand, stocks refer exclusively to securities traded on a stock exchange. However, the terms “stocks”, “equities” and “shares” are used interchangeably in everyday situations.
As corporations issue stocks in order to raise funds to operate their businesses, shareholders are entitled to receive dividends and voters’ rights as, technically, investors own a portion of the company (that portion depends on their stake). The key thing to understand about how the global stock market works is to digest the whole idea of trading – how is it possible that one can acquire a part of a company? The answer is quite simple - investing in stocks is possible for investors from around the world (both institutional and retail) as publicly traded companies are listed on a stock exchange (also known as stock market or bourse).
What is the stock market?
As it was already mentioned above, companies may be listed on a stock exchange. The process of becoming a publicly traded company is called an initial public offering (IPO). When a firm becomes public, its shares can be bought and sold on a secondary market, namely on the stock exchange. Therefore, a stock market acts as an intermediary – it is a centralised location where buyers and sellers conclude transactions. Traditionally, a stock exchange was a physical place, but it has changed a lot due to technological advancements and now an exchange might be electronic as well.
The price of a stock might go down or up – fluctuations in the share price are caused by changes in the supply of and the demand for the stock. Generally, if the company has a successful business with promising perspectives, its share price should go up. The fundamental situation of the firm is absolutely critical, therefore investors focus on financial performance and react to earnings reports. However, there are also other factors that affect stock prices, for instance, macroeconomic data from key economies, the level of interest rates or the market sentiment reflected in key stock market news. Experienced investors and analysts are constantly trying to identify the best stocks to invest in. As a result, one can assume that in the long-run share prices reflect all information – the idea has been known as the efficient market hypothesis (EMH). The XTB Research Department prepares daily analysis and comments on the current events on both local and global stock markets. Our analysts prepared a list of 10 most interesting stocks for 2021 as well - you may find the report here.
Please be aware that the presented data refers to the past performance data and such is not a reliable indicator of future performance.
How to buy stocks?
Even though we’ve already touched on how the stock market works, you may still be wondering – how can I buy stocks? In order to gain access to the stock exchange, a would-be investor first needs to open a brokerage account. In the past, investors needed the direct assistance of a stockbroker in order to buy or sell securities, for instance, via telephone. However, the industry has changed a lot in recent years and top brokerage firms have developed easy-to-use trading platforms and trading apps. As a result, investing in stocks has become easily accessible, as people are now able to buy stocks with just a few clicks.
Nevertheless, what hasn’t changed is the importance of choosing the right broker. The best broker should not only make stock trading convenient and low-cost, but also support its clients in terms of education and market news. This is a critical decision for every trader, which is why we wrote an article that covers that issue in-depth: "How to choose the best Forex and CFD broker?".
Once you’ve opened and funded your brokerage account, you are able to place your first trades and monitor your positions. It would be recommended to become comfortable on the trading platform before you start trading as well. Brokers usually offer some tutorials, but at the same time brokerage firms tend to adjust their platforms so that they become more and more intuitive. Now any would-be investor might think – what does trading stocks look like in practise? How do I choose the right companies? Below, we’re going to present several major concepts of investing in stocks.
Investing or trading?
At the beginning, it is important to understand the difference between investing and trading. While both words are often used interchangeably, they do represent two different approaches of market participants. Investing is usually associated with long-term investors who apply a buy-and-hold strategy. Their goal is to select promising stocks and hold them for months or even years. This group of investors pays attention to fundamentals of certain companies or sectors. Broadly speaking, there are two types of investments – growth stocks and value stocks. The first case represents companies that are expected to deliver high levels of profit growth in the future. As their stock prices could potentially outperform the market, investors are able to benefit from it. There are also value stocks, which are usually described as well-established businesses with good fundamentals. Such companies often pay dividends, which can be another source of income for investors. If you’re interested in learning more about dividends, we recommend reading our article titled “Investing in dividend stocks”.
On the other hand, trading is often seen as a short-term approach. Stock traders usually intend to take advantage of quick price movements. For instance, they might buy a certain stock before an earnings report release or after an unexpected price drop, hoping that the shares will rebound. Some traders hold their positions for less than a day, which is called day trading. Traders are generally experienced market participants that spend a lot of time monitoring the market and looking for market inefficiencies. Experienced traders apply sophisticated strategies and stick to their rules, for instance, they always place a stop-loss order. Apart from that, they might also speculate that certain stocks will fall, which is called shorting a stock. Some people, who have accumulated enough capital and proper experience on the stock market, choose to trade stocks for a living.
Fundamental vs technical analysis
There are two main approaches to investing money in the stock market – fundamental analysis and technical analysis. Both concepts have their loyal supporters who often disagree. Some believe that fundamental analysis is the only appropriate approach, while others claim that technical analysis gives better results. However, as it is usually the case with such dilemmas, the truth lies somewhere in the middle.
Fundamental analysis is a method to assess the intrinsic value of a stock. Investors tend to analyse not only strengths and weaknesses of a certain company, but also the overall economic conditions. Institutional and experienced retail investors often build complex models in order to calculate the target price of a stock, given their own assumptions about the company’s future earnings. As a result, they are able to verify whether the stock is undervalued or overvalued at a time. Brokerage firms cover a great deal of listed companies and research departments often release their equity research reports, which may be particularly helpful while investing in stocks.
On the other hand, technical analysis is based on a chart created by price movements. In this case, market participants try to identify patterns and look for various signals in order to determine where the market is moving. Experienced investors and traders use a wide variety of indicators and make buy or sell decisions based on them. Even though technical analysis is a wide subject, a would-be investor does not need to know everything about it in order to become successful. There are certain simple concepts that are sufficient to embark on stock trading, for instance, support and resistance levels, moving averages or volume analysis. There are also technical analysts among brokerage firms’ employees, meaning that research content often includes comments based on technical analysis– once again this could be helpful in learning how to trade stocks.
Which approach is better then? Generally, it is said that traders often apply technical analysis while long-term investors focus solely on fundamentals. That is correct only to a certain extent. “Technical analysis is all that matters in the short-run, while fundamental analysis is all that matters in the long-run,” someone once said. Here it is worth pointing out that price movements depend on many factors, including the overall stock market sentiment, so it probably wouldn’t be particularly wise to rely on just one stock trading strategy (either technical or fundamental analysis). Applying different concepts seems to be a better solution, and it is a common practice for fundamental analysts to make use of technical analysis in order to find the best entry points. Meanwhile, technical analysts pay attention to some fundamentals from time to time as well.
Investing in stocks is a long journey full of learning, potential victories, as well as failures. It helps to build character as psychology plays a significant role in both investing in stocks and short-term stock trading. It should be noted that would-be investors should not feel discouraged due to lack of knowledge, as even the greatest investors in history did not know how to buy stocks at the beginning of their journey. Starting with small steps and learning through experience will probably give the best results. As the Internet is full of resources about stock trading for beginners or the basics of fundamental analysis, keeping informed about stocks has never been easier.
Is it possible to invest in stocks with XTB?
At the moment, XTB offers stock CFD trading only. This includes over 1500 global stock CFDs, including Apple, Facebook, Amazon, and Barclays. CFD trading allows you to take a position on the price of an instrument without actually owning the underlying asset.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 77% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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