The Stock Exchange For Beginners Guide - Part 1

How To Make Money In The Stock Market?

As I start my guide, about the Stock Exchange For Beginners, where should a newbie really start?

Firstly, I believe, with a realisation. The stock exchange is rarely a place where anyone 'gets rich quick'.

Offhand, I don't know where anyone does that, but certainly not in investments. Sure, some occasional stocks and shares will rise quickly making their owners money, but rarely will you become rich. Bear in mind that if an investment doubles in one year (which is pretty rare) you needed to be already wealthy to make a lot of money. If you invested a thousand, you will have just 'made' a thousand. You aren't wealthy or rich yet.

There are ways for an investor to make enormous profits, but as ever, they involve enormous risks. Things like day trading or options and futures really are NOT for the beginner with limited resources. They are highly technical, involve the potential to lose all of your investment quickly and need constant monitoring. I know that I am quite traditional in this sense, but many options appear to me as if they are little more than a gamble. That is not how a prudent investor operates! Instead look for reliable and predictable companies, quoted on the stock exchange and suitable for beginners.

Second realisation is this ... It isn't easy for beginners to make money on the stock exchange. If everyone could become a billionaire by investing, Warren Buffett would not be famous. It takes time, study and effort and most importantly - independent thought. Not everyone has the will or stamina to carry that through. I know that mine wavers from time to time. Who doesn't suffer setbacks and confidence knocks?

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Thirdly, though it may be a 'hobby', the stock exchange isn't 'fun'. The world of investment is dominated by investment banks and their bankers. They do all the big deals, float companies, issue bonds, trade stocks, bonds, currencies and commodities and make lots of money. They employ some of the world's brightest young MBA's, whom they teach how to make money in the stock market and then they help them to figure out new and improved profit making ventures. They do all this because it is a business, with real money and real profits. Nobody is playing around.

If you want to be successful, you too need to view it as a business. Here is tip number one: if you are interested, go and do some reading about Benjamin Graham. Buy his books and digest. It will take a while, but it is the proper place to start. It was Ben Graham that first coined the idea successful investment is businesslike.

Size isn't everything

All that said, the little guy can still make money investing. I know, I do. Why can't you? Large mutual funds find it hard to invest in small companies, maybe that offers you an edge. Often, Wall Street money managers are so busy working their 15 hour days that they miss wider discoveries in society. Just by going to the mall or supermarket, you might spot lines selling well and get a head start on the analysts. If that approach sounds good, you might like to grab a book by Peter Lynch - he offers guidance on how he finds winners, or as he puts it 'tenbaggers' (information here).

While these small cap stocks can offer some interesting opportunities to make money in the stock market they can be risky. Penny stocks, as many are known (information here), often offer very high growth potential in a way that larger companies cannot. For a firm like GE, for example, it is not easy to double profits - their profits are already massive - but a much smaller company might need to just add a few extra stores or one more product line to it's distribution channels. Or as Warren Buffett explains it, "Elephants don't gallop".

Despite this, while learning and getting started, it is probably wiser to invest in blue chip stocks than small high-growth companies. This is in part because most beginners do not have enough money to take big risks. Of course, there can still be some very real risks in DJIA or FTSE100 companies.

If you really want to learn how to make money in the stock market, then you need to approach it as if it were your own business. A part-time business perhaps, but still a business. That is, after all, how everyone else treats it...

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The wider picture

How aggressive a person should be when they start investing relates to a few key factors: age, financial resources, your wider financial situation and tolerance to risk.

Typically, it is felt that a younger person has more years to make up for any mistakes they make, so can be more aggressive in their stock or mutual fund selection. In contrast, someone with only a few years of their working career remaining ought to be more cautious and protect the money they have already accumulated.

The ability to sell stocks can sometimes be an issue if there is a falling market or the company concerned is very small and not very liquid. As such, an investor's wider financial resources may be an issue. Ideally, before investing there should be some sort of emergency fund or cash buffer in place. The aim is to (hopefully) prevent the need to sell a holding at short notice because of other lifestyle requirements.

This is, of course, also related to risk tolerance. An investor with $1,000 in savings ought not to be investing it all in a start-up where the chance of total loss is high. However, human nature often makes us do exactly the opposite and chase after such high risk options when we should not be. Often, this does not reflect a high tolerance of risk, but a misunderstanding of the risks being taken and the potential rewards available.

In contrast, a person with $1 million available to invest probably can and perhaps should invest a small percentage in one or two very high risk ventures. Much higher risk opportunities often have little or no correlation with the wider economy meaning that they can (though not always) offer true diversification. (This can mean that while the economy and market are both doing well, a startup is closing it's doors).

It is also important to consider your wider financial situation. The first major issue is that your income exceeds your outgoings. If it does not, then sooner or later there will be problems that require you to tap into your portfolio. To be blunt, this one thing - a larger regular income than outgoings - is the key to becoming wealthy. Therefore, it might be that you need to think clearly about how to make money to secure and increase your regular income before you worry about how to make money on the stock market.

There are other more specific issues that might be important as well, for example, do you have outstanding debts? Are you saving enough into some form of retirement plan? These are subjects that often ought to come before direct stock market investment (information here).

These are obviously issues relating to personal financial planning and not equity investing, but they are the solid platform on which a stock portfolio should be built. Therefore, one answer to how to make money in the stock market is to prepare thoroughly so that "life" does not get in the way of your investment performance.

These are the kinds of steps that hedge funds have learned to take. Having found that they are flooded with redemptions from investors if they have a few bad months, most hedge funds now have a two year lock-in period to ensure that investors stick with them. This has proved to be bad for investors if the fund really is doing badly, but it has helped management as well. Knowing that large amounts of money will not be leaving them in a hurry, it has enabled hedge fund managers to take long-term contrarian positions with more confidence.

The stock exchange for beginners can be a daunting way to make a second income. Fear not, with time, you can learn the skills. But, I warn you again that it takes effort, independent thought and study to really do well.