Investing in stocks can be a way to earn money by taking advantage of a company’s success, as the value of stocks can increase over time. But it’s important to do research and understand the risks involved before investing.
Investing in stocks can be a great way to grow your wealth over time. While stocks can be volatile in the short term, they tend to provide much higher overall returns compared to other assets such as bonds and cash savings.
Interested in learning more about how to invest in stocks? In this guide, we’ll walk you through the basics and explain how you can invest in stocks on eToro.
What are stocks?
Stocks are shares of ownership in a company. When you buy a stock, you’re buying a tiny piece of that company.
As the company’s profits (and its value) increases over time, so does the value of your stock. If the company starts to struggle, your stock will decrease in value.
Stocks are bought and sold on stock market exchanges, and their value can fluctuate based on a variety of factors, including economic conditions, company performance, and investor sentiment.
To trade stocks, you need an investment account with a stock broker or investment platform like eToro’s, which offers zero commission for stocks and low minimum investments.
Why invest in stocks?
While there are risks involved, investing in stocks can help you grow your money faster, offering higher potential returns over the long run.
For example, the S&P 500, a stock market index composed of 500 large US companies, has generated an average 10% annual return since its 1926 inception, much higher than government bonds or savings accounts.
But keep in mind S&P 500’s level of return is an average across all stocks in the index — not every individual stock performs this well.
Stock prices also don’t rise in a straight line — they can move up and down and may experience periods of poor performance, depending on the company or broader economic climate.
Despite risks, research has shown stocks are one of the best long-term investments you can make.
5 advantages of investing in stocks
Some benefits of investing in stocks include:
- Higher long-term returns
- Protecting your money against inflation, as stock returns historically outperform inflation
- Easier to buy and sell than other assets such as real estate
- Ability to invest with a relatively small amount of money.
- Option to diversify your portfolio with many different stocks, which lowers your overall risk.
Long-term versus short-term investing
There are two key ways to approach stock investing, depending on your risk tolerance and time horizon. Both types of investors look to profit from the stock market, but pursue this goal in different ways.
Long-term investing is seen as a “buy-and-hold strategy,” while short-term investing is a “buy-and-sell” strategy.
Long-term investing
The goal of long-term investing is generally to build wealth over the long term.
Investors will often hold stocks for years, or even decades, with the aim of generating substantial profits from both rising stock prices and dividends over time.
Long-term investors tend to ride out periods of underperformance, with the expectation that stocks will eventually rebound and any short-term losses will be recovered.
Short-term investing
The goal of short-term investing is to generate short-term profits.
Short-term investors hold stocks for a much shorter period of time than long-term investors, often buying and selling within weeks, days, or even hours.
Instead of focusing on the company’s long-term prognosis, short-term investors focus on which direction the stock is likely to move in the near future and try to profit from that assumption.
Because short-term stock performance can be volatile, short-term trading is often much riskier. Short-term traders must constantly monitor market performance and make quick decisions to buy or sell.
| Long-term | Short-term | |
|---|---|---|
| Time frame | Years | Days, weeks, or months |
| Profits | From rising stock prices and dividends | From rising and falling stock prices |
| Instrument | Stocks | Stocks |
| Risk | Potentially limited to initial investment | Potential for more exposure to volatility |
How stocks generate revenue
There are two main ways to make money from stocks.
Rising prices
If you buy a stock and its price rises, you can then sell your shares for a profit.
For example, if you buy one Amazon share when the stock is trading at $2,000 and it rises to $2,200, you can sell it for a $200 profit, known as a capital gain.
Dividends
Some companies pay out dividends to shareholders, which are regular payments of the company’s profits. These dividends can be reinvested into more stocks or used as a steady stream of cash income.
One example of a dividend-paying company is McDonalds. Here’s a look at McDonalds’ recent dividend history.
| 2019 | 2018 | 2027 | 2016 | 2015 | |
|---|---|---|---|---|---|
| Average dividend per share | $4.73 | $4.19 | $3.83 | $3.61 | $3.44 |
While on paper dividend payments may often seem insignificant, they shouldn’t be ignored. Many studies have shown over time dividends make up a significant proportion of overall stock market returns.
What drives stock prices?
Stock prices are driven by supply and demand, which can be influenced by a number of factors, including:
- Company news: Good news tends to increase demand for a company’s shares, while bad news tends to decrease demand. For example, if a company announces that its quarterly profits are higher than expected, demand for its stock is likely to rise, pushing the price up, and vice versa.
- Competitor news: For example, if a company in a specific sector reports strong annual sales, it may boost demand for other stocks in that industry.
- Analyst ratings: Investment firms like Goldman Sachs, Citigroup, and Morgan Stanley regularly provide stocks ratings, which reflect the expected performance of a stock over a time period. Three common ratings are buy, hold, and sell. If an analyst upgrades or downgrades a stock, it can influence demand for the stock.
- Economic and political news: News regarding interest rate changes, inflation data, unemployment figures, and political turbulence can all impact investor demand.
- Investor sentiment: Investor sentiment refers to the overall feeling that investors have about the stock market. If investors are feeling confident stocks are likely to rise in the future, demand is likely to be high. However, if investors are concerned about market conditions and believe that stocks could fall, demand is likely to decline.
Developing an investment strategy
There are many different approaches to investing in stocks. Investors will often combine a number of these strategies to meet their goals.
The right approach for you will depend on your investment goals and objectives, financial situation, time horizon, and risk tolerance.
Key strategies include:
- Value investing: investing in companies that are trading at a discount to their true stock value. The idea is that if a stock is trading below its true value, it’s undervalued, and may be worth buying. If a stock is trading above its true value, it’s overvalued, and may be worth selling or avoiding.
- Growth investing: investing in companies that are expected to grow at a fast pace. Growth stocks can offer high potential returns, but they can also be volatile and riskier investments.
- Quality investing: investing in companies that are financially strong and highly profitable. High-quality stocks tend to be resilient and can offer protection during market downturns.
- Small-cap investing: investing in small companies that have stock market capitalizations (i.e., the combined value of a company’s total shares) of $2 billion or less. Smaller companies tend to produce higher returns than larger, well-established companies over time, but are generally more volatile.
- Dividend investing: investing in companies that pay consistent dividends to their investors. Dividend investing is popular among retirees and those looking to generate passive income.
- Socially responsible investing (SRI): This strategy, which has become more popular in recent years, involves investing in companies that meet certain environmental, social, and governance (ESG) criteria. SRI investors often avoid stocks in sectors like oil, tobacco, and defense.
Stock analysis basics
Stock research can help you determine which stocks are worth buying and which should be avoided, based on your investing goals.
Two common forms of stock research are fundamental analysis and technical analysis — many investors use a combination of both when making investment decisions.
Fundamental analysis looks at all available company information, including financial performance, financial strength, and competitor threats, to determine whether a stock is undervalued or overvalued.
Investors will analyze financial data and often use ratios to determine if a stock is worth buying. Popular ratios used in fundamental analysis include:
- Price-to-earnings (P/E) ratio: The ratio of a company’s share price to its earnings per share. The P/E ratio is useful in comparing the valuations of different stocks.
- Dividend yield: The ratio of a company’s dividend per share to its share price, often expressed as a percentage. Dividend yield enables an investor to compare the dividends offered by different companies.
- Return on equity (ROE): The ratio of a company’s net income to the amount of equity (assets minus debt) on its balance sheet. ROE is a good measure of how profitable a company is.
With technical analysis, investors use stock charts and analyze trends, patterns, and indicators to predict a stock’s future movements. These investors believe historical price movements can be used to predict future price movements. Popular technical analysis strategies include:
- Trend trading: This strategy analyzes a stock’s trend, which occurs when a stock moves in one direction for a long period of time, to predict future prices.
- Support and resistance trading: This strategy identifies a stock’s support and resistance levels. Support is the price point where a stock is unlikely to fall below, and resistance is the price point where a stock is unlikely to go above.
- Breakout trading: This strategy identifies stocks that have broken through established support or resistance levels. Breakouts can be strong signals, especially when confirmed by other technical analysis indicators.
Risks of investing in stocks
All investing involves some risk and stock investing is no different. Some risks associated with investing in stocks include:
- Market risk: economic developments or other events can impact the entire stock market and send stock prices lower.
- Stock-specific risk: Each stock has its own unique set of risk factors, including company performance or industry performance.
- Liquidity risk: The risk that you might not be able to sell a stock you own at a fair price due to a lack of buyers. Liquidity risk tends to increase during periods of stock market volatility.
- Leverage risk: While leverage is a powerful tool that can magnify gains, it can also magnify losses. If a large amount of leverage is used to trade, even a relatively small price movement in the wrong direction can result in substantial losses.
Risk management strategies
You can never eliminate risk completely when investing in stocks, but you can reduce it.
One effective way to reduce risk is by diversifying your portfolio, or spreading your money over many different stocks or funds so that you’re not overexposed to any single stock.
A diversified portfolio is typically less risky than owning just one or two stocks.
Generally adopting a mix of different assets in your portfolio is a way to diversify and lower risk. This involves investing in multiple asset classes including stocks, bonds, commodities, and cryptocurrency.
Considering a long-term investment horizon is another strategy to reduce the risk of losing money. In the short term, stocks can be highly volatile. But in the long run, the stock market tends to rise. Typically, the longer you invest, the lower your risk of losing money.
Stop losses can help minimize investment losses by closing out losing positions before large losses build up.
How to invest in stocks on eToro
As an eToro user in the US, you can invest in stocks by:
- Log in or create an account.
- Head to our Markets page to access all available stocks.
- Select the stock that you wish to invest in, then select “Invest.”
- Select “BUY.”
- Enter the amount of money you wish to invest in the stock or the number of shares you wish to buy.
- Select “Open Trade.”
This communication is for information and education purposes only and should not be taken as investment advice, a personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments.
This material has been prepared without taking into account any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this publication.