Thursday, January 16, 2014

How to Buy Stocks

Edited by SloWriter, Tom Viren, Alan J, Jack Herrick and 75 others
Buying stocks is not difficult, but you'll need a little guidance if you haven't done it before. On the other hand, making money consistently from buying stock can be very difficult. Most mutual funds underperform the index, which means even professionals don't find this easy. So take everything you read with a grain of salt.

EditMethod 1 of 2: Before You Buy

  1. 1
    Do nothing until you know the kinds of stocks to buy and under what circumstances to sell. Go to the local library and search online to find books and other resources on stock investing. A few excellent books to start with include "The Intelligent Investor" by Benjamin Graham, " Security Analysis" by Benjamin Graham and David Dodd, and "Common Stocks" by Philip Fisher. Also see Invest in Stocks.
    • The rule of thumb with stocks is to buy low and sell high. You want to buy a stock when it's affordable and sell it when it's costly.
      • Say that you buy 100 shares of stock priced at $15 each. That's a $1,500 investment. If, after two years, the stock price has risen to $20, your $1,500 investment has turned into a $2,000 investment, giving you a $500 profit.
      • Say that you buy 100 shares of a stock priced at $50 each. You've made a $5,000 investment. If, after two years, the stock price has fallen to $25, your $5,000 investment has turned into a $2,500 investment, giving you a loss of $2,500.
  2. 2
    Don't get stock prices confused with the value of a company. The value of a company is its market capitalization, or market cap. Market cap is determined by multiplying the stock price of a company by the number of shares it has issued.
    • If the stock price of any given company is $100, and the company has issued 500,000 shares, its market cap would be $50,000,000.
    • Therefore, a company whose stock price is $7 can have a higher market cap than a company whose stock price is $30 — if the first company has five times as many shares issued as the second.
    • The market cap is the overall value of a company's shares, not the value of the company itself. Investors make an educated guess about the value of a company; there's no established way to define it, because you're making a guess about what the company will do in the future.
  3. 3
    Understand a few more basics about stocks. Being successful in the stock market depends on being able to find out what a company's future returns are. This is a guess, a wager. Stock prices are deeply affected by peoples' opinions of how companies are performing, not always the intrinsic value of the stock.
    • A stock price goes up when more people want to buy the stock than to sell it. A stock price goes down when more people want to sell the stock than to buy it. Therefore, the price of any given stock is a reflection of how well people think the company is performing, not necessarily a cut and dry formula for how well the company is actually performing.
      • In this way, a company can have a strong stock price and a lot of shares and still be overvalued, because people think the company is worth more than it actually is. In the same way, a company can be undervaluedeven if it has a mediocre stock price and fewer shares, because people think the company is worth less than it actually is.
      • Your goal in trading stocks — aside from buying low and selling high — is to find stocks that are undervalued and buy them and to find stocks that are overvalued and sell them.
    • Stock prices are also affected by earnings reports, which companies release four times a year. If a company releases strong earnings reports, its stock is likely to go up. If a company releases lower-than-expected earnings reports, the stock price is likely to go down.
  4. 4
    Put your finances in order. Pay off as much debt as you can and minimize the loans you're taking out. Ideally, all high interest rate loans should be completely paid off first, and the only loan, if any, you should have is mortgage on the home you live in. Build three to six months' worth of expense in a separate savings account before you start buying stocks.
  5. 5
    Consider how stocks fit into your overall financial plan, and whether you should buy individual stocks or mutual funds. See How to Decide Whether to Buy Stocks or Mutual Funds.
    • Mutual funds are a collection of stocks bundled into a group. There might be 100 stocks in a mutual fund, for example. So if you invest in that particular mutual fund, you are investing your money in many different stocks, essentially. If the value of one company in the mutual fund goes up, it's not likely to make much difference in the big picture. At the same time, if the value of one company in the mutual fund goes down, it's not likely to have a serious effect on your overall investment.
    • Buying individual stocks is riskier than buying mutual funds. At the same time, the reward is higher. If you buy individual stocks and the value of the stock tanks, you've lost a lot of your investment. If the value of the stock skyrockets, you've made much more money than you might have investing in a mutual fund.
  6. 6
    Do your due diligence. Research the company thoroughly before buying stock in it. You are basically making a bet about how well you think a company is going to perform in the future. Start with online financial sites to get a quick idea of the business and key financial ratios.
    • Look at the balance sheets and income statements for the past 10 years to see if they are sound. Companies with a high debt load and poor record of profitability may be quickly eliminated from further consideration.
    • Read the recent annual and quarterly reports (SEC 10-Ks and 10-Qs). Explore the company's website, if one exists. Read analyst reports, if available.
    • If still interested, you may wish to speak to the company's customers, competitors, and suppliers, then finally the company's executives themselves to get a better idea of the business.
  7. 7
    Make a wish list. Ideally, these should be stocks of great companies that you intend to hold on to through thick and thin. Warren Buffett, one of the best investors today, said that if you cannot hold a stock for 10 years, you should not even consider holding it for 10 seconds.
    • Set a target price to buy for each stock and stick with it. For example, suppose after doing your due diligence, you decide Minnesota Mining and Manufacturing (3M) is great stock to buy, but the price is selling a little too high right now at $95/share. You would like to buy at $80 or less. Taking a look at the price history, you see that the stock is selling at an all time high, and was trading around $80-90 last year, and as low as $45 two and a half years ago. So $80/share is quite reasonable a target. Why not make it a tad lower, say $75?
    • The key to successful investing is to stick with your strategy over long period of time. So once you set your target, and the stock hits the target price, you buy, and continue buying as the stock goes lower.

EditMethod 2 of 2: Ways to Buy

  1. 1
    Buy direct. Some companies offer direct stock purchase plans (DSPPs). Search online or call or write the company whose stock you wish to buy, to inquire whether they offer such a plan; ask them to forward you a copy of their plan's prospectus, application forms, and other relevant information.
    • Most plans allow you to invest as low as $50 per month, automatically withdrawn from your bank account.
    • Pay close attention especially to the fees involved. A few companies, such as Exxon Mobil (see here), offer no fee investment plans.
    • DSPPs also allow you to reinvest all your dividends automatically. Your dividend is a payment made to stockholders, based on the corporate profits of the company. Some companies even give you a discount, such as 5 percent, for dividend reinvestment.
  2. 2
    Use an online discount broker. Search for "online discount brokers" on a search engine to find a list of brokers that you can use to buy and sell stocks online. Be sure to compare their fees and see if they have any hidden fees before signing up. Minimizing fees and expenses is key to successful investing.
    • Most discount brokers charge less than $10 commission per trade, regardless the size of the trade. Some brokers may even offer a certain number of free trades, provided you meet certain criteria, so make sure you read carefully before committing to a broker. The best brokers also offer no fee dividend reinvestment, good customer service, and various research tools for customers.
    • Send the broker an initial deposit of funds. (Your broker needs this money to purchase your stocks.) The usual minimum is $2000 but can be as little as $500.00. Some online brokers don't require a deposit at all.
    • Your broker must report your stock trades to the IRS. You will need to fill out the required forms and mail them back to the broker, possibly even before they will allow you to make your first trade. (Your broker will send you the forms.)
    • Select your stock, notifying your broker of the company's "symbol" (a 1-5-letter code), the price you're willing to pay per share, the number of shares to buy, and the length of time for which your offer will be valid (e.g. Single day vs. Good till Cancelled). Instead of specifying a price you are willing to pay (call a 'limit order'), you may also put in order to buy at the market, which means you order is immediately filled at the current ask price for the stock.
  3. 3
    Alternatively, use a full service broker. A full service broker is similar to a discount broker as discussed above, except that they charge considerably higher fees, and offer investment advice and more research tools. Because full service brokers are paid mostly by commissions, it is in their best interest to encourage you to trade as frequently as possible, even though it may not be in your best interest.


A video that gives tips about managing stocks to first timers.


  • Before you buy anything, stop. Watch. Learn. Paper trade. Don't trust anyone's advice until you have confirmed that what they say works consistently. If you are considering buying a trading system from anyone, look at some of the reputable financial forums such as trade2win or moneytec. You will find most of them there...along with a heap of dissatisfied customers.
  • Try using stop losses with paper trades. If that works well, consider using stop loss before every trade, and exercise it ruthlessly. A 'stop loss' order specifies that if a stock falls below a specified price, the stock will be sold. For example, if you hold 100 shares of Union Pacific (UNP), and the stock is trading at $100 a share. If you enter a stop loss sell order for 100 shares of UNP at $90, your sell order will become a market order when the stock falls to $90 or below. Know that if the stock drops too fast, your execution price may fall significantly below the stop loss price of $90. To protect against executing at a price less than your stop loss price, you can use a stop limit order, which means the stock drops to your specified stop limit price, your order becomes a limit order at that price, and does not guarantee the execution of your order. Don't make decisions on the fly! Be aware, however, that in volatile markets, stocks can easily lose 50% and then go up 5 times the value. It is better to buy low and sell high if you are trying to invest, rather than buying high and trying to sell higher in speculation.
  • There is plenty of free advice from reputable people. There is also plenty of free and seemingly credible advice that is both misleading and wrong.
  • Don't buy too much of one investment, to insulate yourself from firm-specific risk (the risk that an individual stock may blow up due to some unexpected adverse developments in the underlying company); balanced portfolios tend to increase in value in the long-term.
  • Many of the established text books and bibles on trading - particularly on technical analysis - contain assumptions repeated so often they have gained the status of fact without ever being proven! If you find that hard to believe then download a stock price into a spreadsheet and test the moving average crossing methods repeated in every book on technical analysis and shudder at how much money you would have lost! It just isn't as simple as it is painted.
  • Maintain meticulous records of all your stock trades, including the stock, size of the trade, cost basis (price you pay including any commissions, fees, and adjustments), sale price, and dates of transactions. You will need these information to calculate capital gains taxes. From time to time, you will need to adjust your cost basis to account for return of capital, splits, depletion, spinoffs, distributions, etc.
  • Many people erroneously believe that a broker is required to buy stocks. This is not the case. If you feel confident enough, and have the necessary experience, opportunities abound for buying stocks all by yourself without any broker involved. Although this is not an option most beginners consider, it is something you can look into once you've established yourself in the field and have a sound background.
  • Although you should "diversify" your stock portfolio by owning stock in several industries, buy stock primarily in industries you are familiar with. (tech stocks if you're a geek, auto stocks if you read a lot of car magazines, etc.)
  • Most day traders lose money, and very few fund managers beat the indexes over any length of time. Stock trading is easy. Making money is hard. So look for a system, prove it to yourself, and then don't deviate!
  • Know that your investments with each broker is insured by the SIPC for up to $500,000. If you have more than $500,000 with a broker, consider using additional brokers to diversify against the risk of your broker going bankrupt.


  • Do not use market orders for thinly traded stocks; use limit orders only. Thinly traded stocks have much widely spreads, which means a market order can be filled at a much higher ask price than the last traded price of the stock. Stocks can be difficult to find though, so it might take you a while to find a low valued stock.
  • Avoid the common mistakes that plague new comers to the stock market, chief among which is speculation in stocks. Speculation takes many forms, including buying and selling too frequently trying to make a fast profit within months, chasing the hottest stocks (stocks with the biggest recent gains), also known as "momentum investing", feeding the dogs (i.e., indiscriminately buying stocks with the biggest recent losses or trading at low valuations), buying penny stocks (stocks of small companies trading at less than $1), buying stocks on margin, short selling, buying options and financial futures. Speculation in stocks is a long-term losing strategy. If you are not yet fully convinced not to speculate, practice trading on paper, i.e. do not actually trade stocks, but pretend that you are buying and selling stocks, and record the transactions on paper, or in a computer spreadsheet. Make sure to include commissions and taxes in each transaction.
  • Do not let your emotions or bias cloud your judgment when you are buying stocks. Just because you love Krispy Kreme doughnuts does not mean that you should be buying Krispy Kreme stock. Even the best products can be run by companies with terrible management which will eventually run them into the ground.
  • Be cautious with the use of margin in buying stocks. To avail yourself to the use of margin, you must sign a form with your broker, acknowledging your understanding of the inherent risks associated with margin trading. Margin allows you to put up only 50 percent cash and borrow the other 50 percent from the broker to buy a stock position. A cash deposit of $5000, for example, allows you to buy a position up to $10000 with the use of margin. If your stock subsequently loses 50 percent, however, your broker would issue you a margin call to put up more money, or else your position gets sold off to prevent your account from going underwater (i.e. owing more than it is worth). Because fluctuations in the stock market are the norm and can be quite volatile at times, use margin at your own risk.

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