Making money consistently is every trader’s dream; however, it is easier said than done. As a beginner to trading or investing, it will not always be easy for you to end every day on a profit, and sometimes you might even have prolonged periods of losses.
According to the SEC, most people who start day trading initially suffer massive losses, and a huge proportion of these traders never really graduate to profit-making status.
If you’re looking to make money with stocks, you need to have three things: a proper plan, discipline, and diligence.
A proper plan is important because without that, anything you do will have no effect.
Discipline ensures that you make rational decisions and stick to the code, meaning you don’t throw more money after loss-making positions, and you get out at the right time on profitable positions.
Diligence, perhaps the most important of them all, helps you introspect what went wrong after every loss-making trade and enables you to avoid these mistakes in the future. It also keeps you going after a bad day because you are determined to persevere and eventually beat the odds to achieve profit-making status.
In this post, you will learn how to make money in the stock market as a beginner.
NOTE: You can get your free how to make money with stocks PDF below.
How to Make Money in the Stock Market for Beginners
As a beginner, entering the stock market can be a bit intimidating, especially if you are not familiar with the technical jargon involved in day-to-day trading.
Before you can even begin to enter the market, the first step is to learn as much as possible about the market, its biggest players, and how it works. This means you will have to learn stock market terminology, basic concepts about how the market trades function, and have an idea of the various types of instruments you can trade.
You can trade equities, options, futures, commodities, and currencies in the financial markets, so you need to choose the instrument that you wish to trade.
Once you have understood the stock market basics, you are now equipped with the theoretical knowledge you need. What comes next is the practical part, and you can only learn this by actually trading yourself. This can be done in one of two ways:
- Either you begin with a real brokerage account and make small trades/investments to limit your losses. As you go from trade to trade, you will find yourself learning newer concepts and getting a better idea of how the market functions as a whole.
- The second, more often employed option is to set up a paper trading account. Several brokerage services allow you to set up a demo trading account with virtual cash. Once you’ve set this up, you can then begin trading without the risk of losing money hanging over your head.
There are two ways to make money in the market, investing and trading. Both of these have different requirements, timeframes, and criteria.
While most traders are also occasionally investors and vice-versa, you should start off doing only one of the two and then gradually shifting to the other as you get better. Both trading and investing have been discussed below in detail.
NOTE: You can get the best free charts and broker for these strategies here.
Investing in the Stock Market
Investing refers to when you buy the shares of a particular company to hold them for a long period of time.
As discussed earlier, when you buy a share, you effectively buy partial ownership in the company. As an investor, you will be researching companies and their business models, and the process is called fundamental analysis.
Under this, you study a company in-depth by analyzing various factors, such as the profitability of the company, its position in the industry with respect to its competitors, and the efficiency of the company’s management.
Fundamental analysis involves both qualitative and quantitative factors, and therefore, a good investor has to be proficient in both these areas.
Towards the quantitative side, you will need to go through the company’s financial statements and compare its profitability with that of its peers. This is done using various financial ratios, such as the net profit ratio, the asset turnover ratio, and the firm’s leverage. By comparing it to the industry standard, you can get a good idea of whether a firm outperforms its competitors.
Fundamental analysis also involves looking at the company’s future growth prospects, as this will directly affect the company’s share price. On the qualitative aspect, you will be researching the company management, the efficiency of the business process, and other factors that affect the quality and prospects of the company but cannot be expressed as numbers.
How do Investors Make Money?
Investors in the stock market make money in two main ways: dividends and capital growth.
Dividends are a share of the profits that the company pays out to each of its shareholders. Companies usually try to keep the dividend payout percentage stable to keep investors appeased while also saving enough cash in hand to finance future operations. Dividends also serve as a source of passive income for investors.
In addition to this, investors also earn money through the gradual appreciation of the share prices as the company continues to grow and become profitable. For this to happen, they continually monitor the company’s progress and financial position to ensure that it operates in a healthy manner.
Trading in the Stock Market
Trading is very different from investing.
When you invest, you’re looking to put your money into a company because you believe that the company has a strong and stable business model, and hence you wish to grow with the company.
There is a much larger pool of information for you to examine in investing, as you have to look at a wide variety of factors. That is not the case with trading. Often, traders know very little about the companies whose stocks they’re trading. As a trader, the only thing that really matters to you is the share price and the direction in which you can expect it to move.
You identify stocks to trade on through the technical analysis.
Technical analysis involves the process of observing stock prices, their past movements, and the general price trends to try and predict where the stock price will go in the future.
Technical analysts use a variety of tools to identify trading opportunities.
The first and foremost indicator is through previous patterns that the stock prices might have followed, i.e., if you observe that a stock price moves higher at the end of every week, this is a useful indicator to trade on. In addition to this, there are various patterns common to all stocks, and these are generally used by traders worldwide.
In addition to this, traders also use several other statistical indicators that signal trading opportunities and the optimal entry and exit points.
Since traders have a much shorter timeline than investors, they are not worried about the company fundamentals or how they will perform in the long run.
While fundamental events such as earnings reports and government policy changes affect the share price, traders are always more concerned with the impact of these events on the share price than with the events themselves.
Using Stock CFDs
A Contract for Differences (CFD), as the name suggests, is a contract between a buyer and a broker. Unlike trading stocks normally, a CFD is only executed between a buyer and a CFD broker instead of another party.
Another key difference is that the CFD buyer does not get ownership of the underlying asset.
Instead, how it works is that the broker provides them with the difference when their position opens and closes. Suppose you buy a CFD for $10 and sell it for $15; the CFD broker will then pay you $5. However, when the CFD was still open, you still did not own the underlying asset.
Advantages and Disadvantages of CFDs
CFDs have become quite popular in recent times because of the wide variety of advantages that they offer:
- They allow traders to bet on the price movements at a lower cost than they would incur if they bought the asset themselves.
- They allow traders to trade on the price movements of assets that would otherwise be difficult or bulky to buy. This includes commodities such as gold or crude oil, whose prices can be speculated upon through CFDs.
- It also allows traders to open and close both kinds of positions: long and short. These will be discussed below in more detail.
- They allow traders to trade on margin, thus limiting the capital requirements and making trades easier and more accessible for people.
At the same time, there are several disadvantages involved with trading CFDs too, which make certain traders wary of them. These disadvantages include:
- The fact that traders can trade on margin is a double-edged sword; things can just as easily go against them. With margin trades, even a small mistake can lead to catastrophic losses and wipe out your account.
- In addition to this, the need to trade on margin means that traders have to maintain an adequate level of margin at all times to guarantee liquidity, requiring a lot of tied-up capital on the part of traders.
- In several countries, CFDs aren’t regulated properly, leading to issues in terms of inconsistencies and traders not being able to trade the global markets.
Two Kinds of CFD Positions
A major advantage of CFDs is that it allows you to open two kinds of positions: long and short. Each of these positions has been explained below in detail.
A long position is when you buy the security at a low price and aim to sell it off at a higher price later. This is the most common type of trading that people know, and it is the same concept as it is with normal stock trading.
A short position is different, however, in that you sell first and buy later.
The idea here is that you expect prices to fall. Short trades are best explained through an example. Say you expect a particular stock price to fall. It is currently trading at $10, so you ask your broker to let you borrow one share of this company at the market rate. You then sell off this borrowed share for $10, and this is the first leg of the transaction. Then, when the share price falls to, say, $7, you buy a share of the company at this rate to return the borrowed share.
Therefore, you make $3 on this transaction. With CFDs, you can open short positions directly, and therefore this allows you to make money when prices are moving up or down, depending on what positions you have.
Using Stock Options
Using stock options is also a very commonly used way to make money; however, trading on options is a very high-risk high-reward strategy.
Normally, people only begin trading options once they are confident in their ability to trade shares and understand the market properly.
A stock option is a kind of derivative on a stock, which means that when you buy and sell an option, you don’t actually buy the asset; you’re just making a bet on whether the asset’s price will move in a particular direction.
There are two main kinds of options: call options and put options, and they have both been discussed below in detail.
Two Types of Options
An option, in general, is an asset that gives you the right, but not the obligation, to buy or sell an asset at a predetermined rate in the future.
Suppose you think that a particular stock, which is currently priced at $1100, will go up in the future. The ideal thing would be to open a long position on this stock; however, the stock’s high price means that a long position would require a lot of capital commitment.
Another option is for you to buy a $1100 call option, expiring in a few weeks. This means that at any time in the next few weeks until the call option expires, you can buy the share at $1100 irrespective of the market price. To buy a call option, you have to pay a premium.
Suppose the stock price goes up to $1500; you can then execute your call option, buy the share for $1100 and then sell it for $1500 in the market, resulting in a $400 profit minus the premium you paid.
However, if the share price drops; instead, you can choose not to execute the option and let it expire. Thus, buying a call option restricts your maximum loss to the amount of the premium you paid on the stock. This is a call option, where you are betting that the underlying asset’s price will go up.
A put option works in quite the same way as a call option, but instead of providing you with the right to buy a share at the predetermined price, it allows you to sell the share at a predetermined price. Therefore, a put option should be bought when you think that the security price that you own will go down.
How to Make Money on Options
People make money trading options in one of three ways:
- The first way is to trade options directly by buying options contracts based on whether you think a particular security will move up or down and then execute the contract whenever you are right to make a profit.
- The second option is to trade on the premiums on options contracts, which are constantly changing. By buying at a low premium and selling the contract at a higher premium, you can make money.
- The third option most commonly seen is to use options as a hedge against another position you are taking to minimize your risk. Therefore, if your position goes the other way, you make money on your options contracts to offset your loss.
How Long Does It Take to Make Money From Stocks?
Depending on the type of trading/investing you choose to do, your time horizon, and how good a trader you are, it will take different people different amounts of time to become a profitable trader. Some people start making money from stocks in a few weeks, whereas it might even take as much as an entire year for others.
Most traders start making money by making big gains on a few trades or small gains on several large trades. How you choose to make money will depend on various factors that have been discussed below, but again, it is less important to make money than to do so consistently.
Steps to Start Making Money From Stocks
As discussed earlier, there are several steps involved in the journey from a beginner to a consistently profitable trader.
The four main steps are choosing a strategy, your capital amount, your broker, and deciding on what patterns and charts you will be using to trade. Each of these steps has been discussed below in detail.
#1: Pick a Strategy or Trading Method
The first step is to decide on a trading strategy you wish to use and are comfortable with. This will depend on your risk profile as well as your timeline for investing/trading.
For example, you might decide to become a fundamental trader, a scalper, or a swing trader, depending on your preferred mode of trading. In addition to this, you also need to pick a strategy that you will be using. This could be anything from trading based on SMA’s, trading only based on company announcements, or trading options.
Another part of choosing a strategy or trading method is identifying a certain set of securities that you wish to trade. Most traders choose blue-chip stocks from the Dow Jones Index or the S&P 500 due to their high volumes and low volatility. However, your choice of stocks will depend primarily on your risk profiles.
The reason it is important to pick a set of stocks and trade them only is that gradually, this will give you a higher level of familiarity in these stocks and help you become a master trader of these stocks instead of being a jack of all stocks.
#2: Choose How Much You Want to Invest
The next step is to decide how much capital you’re willing to invest.
Several strategies require high amounts of capital; therefore, your strategy will also be dictated by the amount of capital you’re willing to spare and vice-versa. In the first few months, you should not invest any money that you cannot afford to lose since there is a very high chance that you will end up losing this money.
Your initial phase is the learning stage, and you need to be able to trade effectively without worrying about whether or not you will be able to pay your bills on time.
In addition to this, how much money you choose to invest will also affect what brokers you can choose from since several brokers have a minimum investment threshold to meet to be eligible to open an account with them.
If you’re planning to trade on margin, your capital should also account for the margin requirements of your broker and ensure that you still have enough money to be left over for trading.
#3: Choose Your Broker and Trading Charts
The third step is to select a broker. There are several factors to be considered in the selection of a broker, such as:
- The commission that the broker charges. While some brokers are now offering zero-commission trading, you need to know what commission your broker charges on every trade before you make your decision.
- The spread. As discussed in an earlier article, the spread is the difference between the bid and ask price while fulfilling an order, and it is the fee that the broker takes for brokering the transaction. Certain brokers have higher spreads than others, so you should be aware of this too.
- The margin requirements and leverage that they provide. Most brokers provide you with leverage to trade without having to risk a lot of capital; hence you need to check how much leverage your broker allows you to trade on. Different instruments have different leverages, so that is an important factor to consider, especially if you’re primarily planning on trading CFDs or commodities. In addition to this, you should also check the minimum margin requirements to ensure that you don’t accidentally fall short of them.
- The range of instruments they allow you to trade. Most brokers allow you to trade various securities and derivatives, including options, futures, bonds, commodities, and cryptocurrencies. You need to ensure that the instruments that you’re planning to trade are available with your broker.
- Any other hidden charges or fees. Several brokers have additional fees, such as an account dormancy charge incurred if you do not make a certain number of trades in a month. It is important to be aware of these too before you open a brokerage account.
Once you have identified the right broker who fits all the right criteria for yourself, your next step is to set up a trading account (demo or real, depending on your preferences), and have your trading setup ready.
This includes a watchlist of stocks that you are planning to trade and any other important charts. Your charts should also have the indicators that you use already on them. You can set alerts based on price levels and volume levels to alert you when there is a potential buying or selling opportunity.
Traders also like to continually monitor sector and market indices, along with the VIX, to spot any potential market-wide events early on.
#4: Start Trading Stocks
Once you have done all this, the only thing left for you to do is to begin trading stocks.
You should set a cap on either the number of trades you make in a day or the target profit you intend to have in a day. In addition to this, you should also have an ideal risk-reward ratio that you adhere to across all your trades and a maximum % of your capital that you are ready to bet on any given position.
Having rules like this in place and following them will maximize your profit potential and enable you to become a better and more disciplined trader.
There is no shortcut to making money in the stock market. Knowing how the market works is important; however, nothing really replaces the practical experience you will get from trading yourself, and those lessons are invaluable.
Once you’re confident that you have understood the basics, you should follow the steps above and begin trading. As they say, practice makes perfect.
Nishit is an accounting and finance student at the University of Warwick who has written for a range of blogs and websites including Fortune 500 companies.
He has a passion for the financial markets and has been a keen investor since he was 15.