How to Take Advantage of the Stock Market

Floor brokers on the New York Stock Exchange execute buy and sell orders.
i Kim Steele/Photodisc/Getty Images

Trading stocks is not a new phenomenon. The contemporary American stock market dates at least as far back as 1792 when a group of merchants and brokers met under a buttonwood tree on Wall Street in New York and laid the foundation for what was to become the New York Stock Exchange. Today, buying and selling stocks has never been easier. Making money in the stock market, however, is a different matter all together.

Step 1

Create an investment road map. Point A is where you are financially right now, and point B is where you want to end up. Unless you know where you are and where you want to go, you might as well be throwing darts at a stack of stock reports. Determine your net worth by listing all of your assets and subtracting all of your debts. Create a budget by listing all of your monthly income and subtracting all of your monthly expenses, including money that goes into savings. The amount you have left over is your discretionary income. This is the money you have to invest in the stock market.

Step 2

Determine your aversion to risk. All investments in the stock market, regardless of how big, old or stable a company might be, are subject to some level of risk. A general rule of thumb when it comes to investing is the greater the risk, the greater the potential reward. The operative word in that phrase is "potential." The opposite is also true. The greater the potential reward, the greater the risk of financial loss. You must ask yourself some hard questions about your relationship with money. Can you sleep at night knowing your investment might lose half of its value before morning, even it it has the potential to double its value overnight? Does earning two percent on your money frustrate you to death, even if there is no risk of loss involved? Knowing your aversion to risk will help you determine what kind of stocks to invest in.

Step 3

Determine your level of expertise. Are you a hands on investor who relishes research? Does the thought of having to wade through stacks of information on thousands of potential companies in order to find the right stock give you the willies? Do you need someone to hold your hand while you invest, or do you just need a little help every now and then? The answers to these questions will help you determine whether you need to use the services of a full-service broker who advises you, a discount broker who is available if you need him, or an online brokerage firm where you make all your own investment decisions.

Step 4

Open your account and start trading stocks. Some brokerage firms may require you to make a minimum deposit to open an account. These funds are usually put into a money market account that is used to settle your purchases. Keep in mind that investing in the stock market should be done with long term money, which is money that you will not need for the next three to five years. The market will fluctuate, and if you are using money that you absolutely have to have next year, you may be forced to sell your stocks at a loss before you are ready to do so. Better to keep short term money in a less volatile environment such as a money market account or bank certificate of deposit.

Step 5

Diversify your holdings. The best investment advice of all time is simple: don't put all your eggs in one basket. Spread out your investment money over several stocks in different industry sectors so if the bottom drops out of one, you still have others that may be performing well. If you don't have enough capital to diversify your portfolio, you may consider investing in a mutual fund, which offers the twin advantages of diversification and professional management.

the nest