How to invest: Trading on the stock market
Buying and selling securities through the stock exchange is one way to value your savings. However, it is one of the riskiest activities that exists in investing. You can make quite a lot of money, but you can also lose money. It depends on which stocks you plan how to invest in, how much time you can devote to monitoring the market, what knowledge (or experience) you have, whether you are investing in dividend-paying stocks or just planning to speculate on price changes, but ultimately it also depends on luck. So let’s talk about stock trading.
The stock market is where the supply of free money meets the demand for it. It is the part of the financial market that we can call the capital market. That is to say, a place where long-term securities are traded, most often stocks or bonds.
What is stock market trading
It is important to know that there is not only a market for securities that have already been issued, but also a market where new issues have yet to appear. From this point of view, we therefore distinguish between a primary market and a secondary market. An issuer of securities enters the primary market in order to raise as much money as possible from investors to finance its (usually business) activities.
The primary market is therefore the place where the opportunity to invest in a particular security (share, bond) first arises. In the case of the primary stock market, this is usually the point at which a given title is listed on a stock exchange and the company in question becomes (partly or fully) publicly traded. We are talking about what is known as an IPO (Initial Public Offering).
An initial public offering can take place in the standard way, where the company going public usually hires a banking house to prepare everything it needs. In particular, a prospectus which contains all the relevant information about the planned issue.
However, this process can be lengthy, and so, particularly in the US, the possibility of going public through a so-called SPAC (Specila Purpose Acquistion Company) has developed. This translates as ‘company formed for the purpose of acquisition’. In practice, it is a company that has been set up purely for the purpose of trading publicly on a stock exchange and with which a company wishing to list its shares will merge. Thus, SPAC companies exist only on paper, have no business activities and generally no offices or employees.
Thus, once an IPO or public offering of shares (selling them at a pre-announced price) takes place, the shares of that company become traded on the secondary market. In other words, shares that have already been traded once or more are traded here. While the selling price of the shares on the primary market affects the final yield for the issuer, developments on the secondary market effectively have no effect on the yield for the issuer. On the secondary market, shares are already bought and sold de facto for two reasons: 1) I want to profit from the rise or fall in their price, 2) I want to get a share that will pay me a regular and decent dividend.
How to invest money in the stock market?
Thinking of becoming a stockbroker? Well why not, it’s nothing too complicated. However, you should always bear in mind that it is a fairly risky business, so you should approach investing in shares with caution. Especially if you have little or no experience.
And especially in light of the relatively small demands that are placed on you before you start trading on the stock exchange. In fact, all you have to do is choose a broker (the person who will broker your trading on the exchange) and you’re good to go. But beware, any reputable broker should warn you of the risks involved in buying and selling securities. You should even fill out an investment questionnaire before actually entering into a contract with a broker. To be more precise, its completion by you is required of the broker by Directive 2014/65/EU of the European Parliament and of the Council on markets in financial instruments and by Act No. 256/2004 Coll. on capital market undertakings.
But how to find the right broker? The safest bet is to look among those who have been established in the market for some time. There is a fairly solid selection in the Czech Republic, and it is not necessary to choose only from these twelve to trade on the stock exchange. Today it is quite common to use trading apps, which are also backed by brokers from abroad.
The following criteria may help you choose:
- Check the broker’s location and what regulation it is subject to
- Find out whether it offers the instruments (asset types) you want to trade
- Find out how much the broker charges, either for brokering the buy/sell or for account management
- Try trading on their platform and demo account, if they don’t offer this option, it’s probably not a good choice
- Contact customer support to check the quality of the service provided
If you have chosen a broker, open an account with them and start trading. A trustworthy broker should also follow the regulatory requirement to segregate the client account (or the money deposited in it) from their own accounts. You should also know that the money you have deposited with the broker is legally insured. However, unlike money in a bank account, this is only up to 90 per cent, but up to a maximum of €20,000.
How to choose the right shares and follow the market
There is nothing complicated about the trading technique itself. In fact, you could try it out with a demo account at your chosen broker. Now comes the hard part of investing in exchange-traded shares. Namely, choosing the right stocks. But how do you know?
The important thing to remember is that there is no universal criterion to say “avoid these stocks” or “these stocks are safe”. Similarly, there is no magic strategy that will ensure your success when trading the stock market. Trading and investing is about working with statistics, managing risk and money, and it is largely about psychology. If you can manage these categories well, you have a chance of profiting in the markets over the long term.
Before actually choosing which stocks to invest in, be clear about what you expect to get out of it. Do you want to make a lot of money in the relatively near future? Well, who wouldn’t. But making a lot of money, fast, is a bit of a stock market squaring circle. If you do try to do so, it means taking a huge risk, sitting at a computer practically 24 hours a day, monitoring what is happening not only in the markets but also in the global economy and assessing the possible impact of one or another political decision in major countries around the world.
The more sensible option seems to be to observe the market for a while first, assessing how the stocks of companies in different sectors are developing, how sensitive they are to the course of the business cycle, central bank decisions on monetary policy or, well, geopolitical events. It is very likely that pharmaceutical companies will be on the rise during a health crisis, and arms companies during war conflicts. If the world’s major central banks signal an interest rate hike, then that is bad news for equities en bloc.
In the long term, it pays to invest in shares of companies that are subject to the described external influences as little as possible. This may be the case, for example, for companies in the food sector, the healthcare sector, but also, for example, the energy sector. On the other hand, companies sensitive to the economic cycle include technology titles, energy companies (mainly mining) or the banking sector.
If you want to delve deeper into market observation, you can follow the analyses of various consulting firms. The analyses are basically of two types: fundamental and technical. Fundamental analysis is based on the tangible results of a company or circumstances that may affect its situation. In addition to financial criteria (such as profitability, turnover, etc.), criteria that affect the corporate environment can also be taken into account. Technical analysis, on the other hand, is based purely on the historical development of the value of a given stock on the stock exchange. For long-term decision-making, fundamental analysis is more relevant, while in the short term, technical analysis can be relied on. However, both have their limits, which lie in the fact that you may have missed something or that history may not always repeat itself perfectly.
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How to invest – minimise the risks
It has been said several times that investing in stocks is one of the riskiest ways people try to value their savings. However, this does not mean that the risks outlined cannot be reduced. The key is to build an investment portfolio. Its composition should be such that a fall in the value of one asset type is offset (ideally outweighed) by an increase in the value of another asset type. This portfolio composition is called diversification.
Portfolio diversification can also be achieved by investing in equities. In short, the idea is not to invest the entire amount of money we have set aside to buy shares in just the shares of a single company or a single sector.
A balanced stock portfolio can be made up of titles that are sensitive to the course of the business cycle, but also those that hold value regardless of how the economy is currently doing. The weight we assign to each type of stock in our portfolio depends primarily on our preferences, or more specifically, our relationship to risk.
If we are willing to take risks, we may invest more heavily in cyclical stocks, which typically include some energy (especially mining) companies, banking titles, construction companies, and, more recently, shares in arms companies. Titles that are not so subject to economic cycles include (as also mentioned) shares of food companies, healthcare companies and so on.
If we choose to keep a low profile, then it is advisable to “load up” our stock portfolio with more non-cyclical titles. If we are risk neutral, our stock portfolio should be equally neutral.
Investing in so-called dividend stocks can also be considered prudent. You generally do not expect or anticipate rapid and significant appreciation, but you do expect to collect a share of the profits from holding them. And if, during the period you hold the share, it also rises in value, consider this an additional return.
However, we should not forget one more parameter that can affect our success or failure in investing in shares. And that is the liquidity of a particular stock exchange and a particular stock title. The liquidity of a market or stock is a characteristic that tells us the volume in which a particular market or stock is traded.
The lower the liquidity, the less frequently a share price is formed in that market and the more risk we take. In fact, sometimes it only takes one or two trades to produce a price, which can fluctuate significantly. Conversely, in markets where huge volumes of shares (and therefore money) are traded, the clearer such a market is, including its share price formation. A relatively illiquid market is the Prague Stock Exchange and the secondary market within it. In contrast, the well-known stock exchanges such as Frankfurt, London, New York and Tokyo are among the very liquid markets.
When investing, also remember to set an investment goal. Do you want to make a profit on share appreciation or is a stable dividend yield more interesting to you? And determine your strategy. Will you buy stocks regularly in smaller volumes (recommended), or will you take a risk and try to buy when the value of the stock is low?
How to invest – Some tips for successful stock trading
The worst thing that can happen to you when trading the stock market is to succumb to your emotions. That’s why it’s a good idea to set a goal for your stock adventure in advance. And then stick to that goal or plan. Be prepared for the fact that the stock market is largely influenced by investor psychology. It is very easy to fall into a buying frenzy and invest in stocks almost without thinking, as well as to fall into a selling panic.
One rule of thumb is that it pays to buy when the market is bouncing off the bottom, and to hold stocks when the market is falling. And when it’s falling, take the opportunity to buy a few shares at a good price. The famous American investor Warren Buffett even believes that a successful strategy is to go against the market. That is, when everyone is selling, you buy. And when everyone buys, you sell. You can try it. But at the same time, keep an eye on what’s going on around you, especially the policies that central banks are making or are about to make. If monetary tightening is on the horizon, stock markets are likely to head south. If central banks are easing policy, stocks are likely to rise.