Some people dream of creating riches by placing a few trades on some hot stocks. Sadly, buying stocks can end in a nightmare if you press the “Buy” button on your online trading screen without first doing some homework. There’s a big difference between guessing on a few shares and making money buying stocks. Although the road to being a successful stock trader is long, a few basic steps can get you started on your path to stock market success.
Write down clear, actionable goals for your money. Although this doesn’t seem to have anything to do with stock-market success, having a clear idea of what you’re trying to achieve will help separate which stocks can meet your goals from those that are either too risky or not volatile enough. The Financial Industry Regulatory Authority recommends not just using goals for stocks but for your entire investment portfolio.
Invest in stocks you understand. Financial guru Peter Lynch built a fortune for many people with the mantra, “Buy what you know.” Lynch advises people to begin with a list of companies whose products and services you admire, then researching from that list to find your investment opportunities. You’ll be more likely to track the company and grasp product and management news if you understand how the company operates.
Focus on fundamentals. Warren Buffett, one of the world's richest stock-market investors, focuses on finding companies he feels are underpriced. Learn about price-to-earnings ratios, which give you a feel for the risk of the company. A firm with a lower PE ratio than its competitors may be underpriced. Peter Lynch looks for companies that consistently grow earnings by 20 to 25 percent per year. Stock screener websites will help you find fundamentally sound companies to explore.
Buy the smallest companies on your list to increase potential returns. Historically, micro and small company stocks have earned the highest returns. If your goals allow for high volatility, focus on stocks with a market cap below $2 billion. If that’s too risky, focus on the smallest fundamentally-sound companies your goals and risk tolerance will allow. You can find the market cap of your favorite company on any reputable Internet financial site, such as Yahoo! Finance or ETrade Clearstation.
Set stop losses, sometimes called sell stops, to minimize the drag of losing stocks on your portfolio. Although stop losses won’t make you money, they’ll prevent everything you gained from a winning stock from being torpedoed by a counterpart that loses everything you’d worked to achieve. Stop losses are trade orders placed below the current price of the stock. If the stock plummets to the stop loss, a sell order will automatically trigger.