The stock market, or equities market as it is also known, is one of the world's most popular and actively traded financial markets. It's also a place where many people go to try to make money, both quickly and over the long term. There are many ways to make money in the stock market, using both traditional techniques and some more innovative methods.
What Are Stocks?
Ownership of stocks technically represents the ownership, or at least partial ownership, of companies. Owners of stocks in most countries have a legal right to vote at company shareholders' meetings and will receive a notice when the meetings are held. After shares are issued by companies, they can be (and usually are) traded successively on the secondary market.
There are several ways to make money with the purchase, ownership and sale of stock in the stock market:
Stocks whose companies are expected to experience strong growth are known as growth stocks. One of the main ways traders can make money with them is holding their shares until they increase in price, and then selling them to take a profit (otherwise known as a capital gain). Sometimes, share prices will fluctuate wildly in volatile markets, offering traders opportunities to buy, sell and take profits quickly.
When companies first issue shares to the public, they hold initial public offerings (IPOs) to allow first purchase rights to potential buyers. Some IPOs are closely watched and heavily traded. That's because stock prices from promising new companies can be bid up quickly from low levels to very high levels in a short period of time. This produces opportunities for quick and sometimes steep profits.
As the name suggests, value stocks are those that are undervalued by the market, presenting a good bargain for potential buyers. Value investing can require thorough analysis of a company's financial statements to understand its financial health and future potential, but this may be worth the effort.
Famed investor Warren Buffett is one well-known proponent of value investing. Inspired by the value investing techniques of investing theoretician Benjamin Graham, Buffett was able to amass a fortune seeking out undervalued stocks over a period of several years. Graham believed that stocks represented a good deal when they were priced at two-thirds or less of their "intrinsic" value.
Holding income stocks is a traditional way to make money in the stock market. Stocks of companies that earn solid revenues often pay dividends, usually on a quarterly basis, to stockholders. Stocks that pay relatively higher dividends, or income stocks, can frequently make money for their owners. However, traders may often have to accumulate large amounts of such stocks to receive significant dividend payments.
Holding mutual funds, or exchange-traded funds, is another way that traders can make money on stocks. A fund is made up of a group of financial assets, often stocks, that are bundled together as a single security. Mutual funds often require minimum purchase amounts and are not traded during market hours.
Exchange-traded funds are similar to mutual funds, but are traded during market hours as if they were individual stocks and can be bought and sold in smaller increments than mutual funds. Both mutual funds and exchange-traded funds that hold stocks often pay out dividends from their holdings on a regular basis.
Stock Options And Futures
The options and futures markets are technically not part of the stock markets, but they can provide good opportunities for making money with stocks.
In options trading, traders can obtain the option to buy or sell a stock for a specified price at a future expiration date. If the stock's market price is higher or lower than the option's specified strike price at its expiration date, then the holder of the option can exercise their buying or selling right and pocket the difference between the two prices. Options can also be bought or sold on the secondary market before the expiration date. Similarly, futures contracts are sold for certain major stock indices and some individual stocks.
Futures contracts are sold at an estimated future price for the index or stock. The contracts generally expire four times per year, once near the end of each quarter. If the stock or index value is higher than the futures price at expiration, the buyer of the contract can take a profit. If the value is lower, the seller of the contract takes a profit.
Preferred Stock Vs. Common Stock
Stocks are usually issued in two types: preferred stock and common stock. Common stockholders, as mentioned above, are given voting rights. Preferred stockholders don't have voting rights. However, preferred stock usually receives higher dividend payments than common stock and has greater guarantees of repayment should the company declare bankruptcy.
Some preferred shares are also convertible into common shares. These shares can be converted at a predefined ratio. If the price of the convertible preferred shares is lower than the price of common shares after the conversion rate is applied, the preferred shares can be exchanged for common shares at a profit to the shareholder.
Short-selling a stock is another common way of making money with stocks. While traders often think of buying, or going "long," on stocks they think will rise in value as a way to gain money, short-selling takes the opposite approach.
Short sellers borrow shares, usually from their broker, in order to sell, or "short," stocks they think will fall in value. After the shares fall in price, they buy them back and return them to the lender. They pocket the difference in the price at which they sold the shares and the lower price at which they bought them back.
Stock splits can at times be approved by company boards and shareholders. When a stock split occurs, the shareholder is granted a multiple number of additional shares for each share held, in ratios of 2-to-1, 3-to-1 or more. The value of each share is divided in a corresponding manner. But when a split takes place, the shareholder's potential future holdings of the company, and corresponding wealth, may be boosted significantly.
There are a variety of ways to make money in the stock market, and thus it is a place where many traders go to seek creation of wealth. Stocks, like any financial trading, can involve potential risks and losses. But traders may improve their chances by becoming familiar with the many avenues in which to use the stock market to their advantage.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…