Investing in the Stock Market takes a general understanding of trading basics, order entry and an overall objective. Let’s explore some of the things we need to consider when investing in the stock market.
What we will cover
- Investment objectives
- Index Funds
- Mutual Funds
- Robo Advisor Accounts
- Buying Individual Stocks
- Trading Basics
- Basic Order Entry
- Bull Markets vs Bear Markets
- Basic Stock Trading Terminology
- Basic Trading Psychology Points
There are many different ways to gain exposure to the equity (stock) markets. A good place to start is by getting an understanding of one’s own investment objectives and the type of investor one wants to be. Will you be an active trader? A passive investor? Pick individual stocks? Have a financial advisor pick them for you? Or, perhaps invest in Mutual Funds so that you don’t need to worry about picking them yourself (but paying someone else – the fund manager to do it for you). Knowing yourself and having a game plan will reward the investor instead of figuring it out along the way. Some people invest in the stock market for capital preservation, some for aggressive growth, some for income. some for speculation.
These goals are known as investment objectives and have a lot to do with one’s risk tolerance.
Once a potential investor has decided on an investment objective, the investor is going to need a broker. The broker provides access to the various stock markets. There are self directed online brokers like Ameritrade, Etrade, & Robinhood. Some people prefer to work with a Financial Advisor at a bank or brokerage (these advisors generally earn sales commissions off products sold to an investor – or other fees).
Index funds are a basket of stocks or other securities that track a larger or broader index (group of securities.) This allows an investor to gain exposure to multiple securities in one product. A great example of an index fund is the SPY. SPY is an ETF (Exchange Traded Fund) that is designed to track the S&P 500 stock market index. The S&P 500 is a collection of 500 US stocks that represent the broadest measure of the US economy. Some of the popular stocks that are part of the S&P 500 include AAPL – Apple , NFLX – Netflix, NKE – Nike, PEP – Pepsi and QCOM – Qualcomm. There are 495 more Large Cap Companies that comprise the S&P 500. All of these stocks are then packaged altogether into one product for investing; symbol SPY – SPDR S&P 500 Trust ETF. It is one great way to get exposure to the largest companies in the USA in one product.
While SPY is the largest Index Fund and arguably the most popular, there are many other Index Funds available for investors. There are other stock index funds, bond index funds, real estate index funds, energy index funds, health care index funds and more. There are index funds that cover most major market sectors. Index fund investing can be a great and more simplistic way for an investor to get exposure to certain market sector while minimizing individual stock risk. Index funds may also require less research and time dedicated to your overall investment portfolio.
An ETF is an Exchange Traded Fund. ETF’s are similar to Index Mutual Funds, but trade just like stocks. ETF’s trade throughout the trading session on the US exchanges. The SPY we just discussed is an example of an ETF. ETF’s have several advantages over mutual funds such as potentially lower costs – there is no advisory fee paid directly to a mutual fund manager. However, ETF’s do contain fees as well. These are known as the expense ratio. It is important to keep an eye out on the expense ratio if you are considering an ETF, as it will consume a portion of your total return. The average ETF’s expense ratio is 0.44%.
ETF’s can make the investor’s life easier by buying a basket of stock exposure in a single product. Some popular ETF’s are SPY, QQQ (PowerShares QQQ – a collection of 100 of the NASDAQ’s largest nonfinancial companies), GLD (SPDR Gold Shares ETF – aims to track the price of gold), EEM (iShares MSCI Emerging Markets), XLE (Energy Select SPDR). There are many more choices. According to research firm ETFGI, there are now at least 5,000 ETFs trading globally, with more than 1,750 based in the U.S.
Above all, ETF’s provide simplicity and an easy way to gain exposure to many securities in one product. This convenience does come at a cost; the fees. So, be sure to keep an eye on the expense ratio.
A mutual fund is an security that allows investors to pool their money together into one professionally managed investment.
Mutual funds can invest in stocks, bonds, cash or a combination of those assets. The underlying security types are called holdings; that combine to form 1 mutual fund; which is also called a portfolio.
Mutual Funds provide a great way to get involved in the stock market; without having to select individual stocks yourself or dedicate much time to research. The mutual fund manager will do all of this research for the investor. The average expense ratio for actively managed mutual funds is between 0.5% and 1.0% and typically goes no higher than 2.5%, although some fund ratios have gone higher. Now, let’s just hope she is worth her weight in gold!
Next, it is important to know that investing in mutual funds does have many advantages.
First and foremost, diversification comes to mind. One mutual fund an hold hundreds or even thousands of underlying assets. This diversification significantly reduces single stock risk. If you have a mutual fund that contains 500 stocks, and one stock performs poorly, the remaining stocks will outweigh and smooth out that risk.
Next, we have Affordability. Say there was a Mutual Fund you liked that had 500 technology stocks. Imagine what it would cost to buy a share of all 500 stocks individually? Mutual funds allow investors to own fractional shares of their underlying assets. Mutual Funds usually have rather low initial purchase minimums and many of them allow you to incrementally add to you holdings monthly with smaller amounts. These funds are managed my investment professionals called Fund Managers. They are experienced in investing money and have the education, skills and resources to research many investment opportunities.
Mutual Fund Loads (Sales Charges)
So, with all of the benefits that come with the mutual funds – (surprise! Surprise!), they come with fees called loads. There are different types of Mutual Funds including Class A Shares (Front End Load), Class B Shares (Back End Load), Class C Shares (Level Load) and No Load Funds.
Class A Shares – Front End Load. A Load, or sales charge, is a charge to pay for the services of a financial professional or investment advisor. These charges can be 5% and higher. The load is paid when the Mutual Fund shares are purchased. Many times, there are breakpoints. Breakpoints are the dollar amount thresholds where the Front End Load will decrease (i.e 10K, 25K, 50K, 100K, etc.). Be sure to ask about the breakpoints if you are considering a large investment in Class A Mutual Funds.
Class B Shares – Back End Load. No sales charge up front – but the sales charge is paid upon the sale or redemption of the shares. The fees in B share tend to be higher than A shares, typically. Usually the sales charge is waived if the investment is held long enough – beyond a specified period in the Fund’s Prospectus. If the shares are sold before the holding period is up, there could be sales charges up to 6%. Be sure to know the holding period and read the Fund’s prospectus. These holding periods for B shares can typically be 7 years. Class B shares can eventually exchange into Class A shares after seven or eight years. Read the prospectus.
Class C Shares – Level Load. No sales charge up front, no sales charge upon the sale, just an annual charge usually near 1%. This annual charge is continuous, which makes owning C shares the most expensive for investors that hold for long periods of time. These may be best utilized for short term holding periods.
No Load Mutual Funds – There is no sales commission on these Mutual Fund Shares. There is still an annual 12b-1 fee up to 0.25%. This is what a mutual fund can charge to cover the costs of their distribution such as as advertising. The Class A, B & C shares also contain this 12b-1 fee. No load funds are tremendously less expensive than the A, B & C shares. There are some no load funds that do not charge the 12b-1 fee. Do your research to find the best fund for you! No load funds are great for the fee-conscious Mutual Fund investor that wants lower expenses.
Robo-advisors or robo-advisers are a class of financial adviser that provide financial advice or Investment management online with moderate to minimal human intervention.  These products and services provide algorithmically driven financial services with minimum human supervision. Typically, data is collected from clients about their risk tolerance, financial situation, objectives, etc via an online form. The data is then used to create a robo-plan for investment of the client’s assets. They are typically lower in fees when compared to dealing with a human advisor, but naturally lack the connection and relationship that one may gain with a financial advisor. Low fees and efficiency are the typical benefits of using a Robo-Advisor account.
Buying Individual Stocks
Perhaps you are the kind of person that wants to do the research for yourself and pick your own stocks. Way to go if that is you – this can be a great way to have control over your financial life. So, we want to purchase some individual stocks. What do we do?
First, we are going to need a broker. There are many discount brokers these days with low to zero dollar commissions for stock trading. Some will even give you a share of stock – they all want your business! You can see the promos on this page for some of the current exclusive offers.
Once we have our broker selected, we need to open an account. Although not a very rigorous process, we do need to sit down and spend 20 minutes or so filling out the online forms. Expect questions about your income, assets, risk tolerance and objectives. Once the application is submitted and processed, your account will be opened. Once opened, the account will need to be funded. Funding options are usually flexible; with choices such as ACH debit, Wire, Check, etc. Once your account is ready and your funds are cleared, you will be ready to trade!
Trading Basics / Basic Order Entry
Assuming an investor has opened an account online with a broker like Ameritrade, Etrade, Schwab, etc. , there will be an online platform or at minimum, a user interface to enter buy and sell orders. So, let’s say we log in and we want to buy some MU – Micron Technology today. We check the quotes and we see it is last trading at $57.84. We have been following the stock for a while and have used some technical and fundamental analysis. We really do want to buy some Micron, but not at this price. We want to buy it at 53.00. How do we enter the order?
First, we want to use a LIMIT order. A limit order allows an investor to sell or buy a stock once it reaches a given price. A BUY LIMIT order executes at the given price or lower. This is in contrast to a MARKET order. A MARKET order will execute the trade at the current price.
So, we want to buy $530 + commission and fees worth of Micron Stock. All broker platforms are different but in essence we would enter 10 under quantity, BUY, Order Type: LIMIT & $53.00 for the price. In addition, there may be a field for duration or TIF (time in force). You can enter DAY (means order is good for the day and will be canceled at 4PM when the market closes), GTC (good til canceled – if MU doesn’t get down to your limit price of $53.00 today, the order will remain working and will be working in the next trading session; or until you cancel it. Some brokers will have a GTD field (meaning Good
Through Date – you can enter a date here and the order will be canceled after this date) or there may be a field for EXT (extended trading hours). Since all brokers are different, be sure to check with your broker regarding the order types and choices that they have to offer. Some brokers will have more sophisticated order types than others.
But for our educational intents and purposes here we want to:
BUY 10 MU LIMIT $53.00 GTC
If you called your broker, you could say “Buy 10 shares MU Limit $53.00 Good Til Canceled”
This will keep your order working until you cancel it. So, if MU doesn’t get down to $53.00 in today’s trading session, your order will resume working in the next trading session and until it is either filled or you cancel it.
So, sticking with this GTC order type, let’s assume that MU does not trade down to the specified limit price in this trading session and it closes at $54 with a low of the day at $53.98. This GTC order will be working in the next session.
Now What If MU Opens The Next Day Much Lower?
Let’s discuss an example in the real trading world that can happen frequently. Let’s say that before the market opens the next morning, Micron warns that their chip orders are looking weak for the current quarter. Investors don’t like this and the stock is expected to open lower. This is known as a GAP DOWN; when the opening price of the next day is below the closing price of the previous day. The opening bell rings at 9:30 AM and Micron MU opens at $51.20. What happens to our buy limit order at $53.00? In this case, our order will be filled on the open at or near the opening price. Remember, our order is to buy 10 shares at a limit of $53.00. This means we will not pay more than $53.00, but we are of course willing to pay less. In this scenario, or order to buy 10MU would be filled near $51.20 on the open.
Now What If MU Opens The Next Day Much Higher?
Your Buy order will continue to work in the market until $53.00 is breached or until the order is canceled with this GTC order example.
What If We Change Our Mind?
This GTC order example can be canceled anytime as long as the order is not filled.
What Stocks Should An Investor Buy?
There is no right answer to this question. Many asset managers subscribe to the belief in Modern Portfolio Theory (MPT). It is a mathematical formula for constructing a portfolio of assets so that risk risk reward ratio is maximized. However, what works for one investor’s goals and risk tolerance will not work for another. Anticipated holding periods, liquidity, tax implications and more will impact what stocks are right for an investor. Do You Research And See What You Feel May Work For You! Or, always feel free to consult with a professional.
Bull Markets Vs. Bear Markets
Bull Market: A Bull Market in the stock market is when the majority of investors are buying. This buying causes overall price to increase. Bull Markets usually occur when economies are doing well, unemployment is low and economic indicators are trending upwards. Tidbit: A bull attacks buy thrashing with his horns in an upward motion – this is where the term originates!
Bull Market Phases
Accumulation Phase: In economics, there are three phases to a Bull Market. The first phase is known as accumulation. This is usually the part of the cycle when the market has been in a downtrend and it seems like there is no end in sight. The major market bottom of 2009 is an example of the beginning of this accumulation phase. Everybody seems to be panicking at the market bottom and it can be hard if not impossible to know when it is happening. The accumulation phase is a phase of sideways price action with no clear trend with prices trending within ranges. Many of the larger players are accumulating their positions during this “basing” period.
Public Participation Phase: This is the time where news starts to improve and the public starts to get involved buying shares. Good news is in the market and things are looking rosy – it really gets the bull market roaring. This is historically the longest lasting of the 3 bull market phases with the largest prices appreciation The new upward trend is in place.
Excess Phase: This phase of the bull market has just about everybody involved and it may seem that the market will never go down again. The tech run-up in the late 90’s – 2000 is an example of this phase. Many professional investors begin to sell as they forecast a pullback in prices. It is key to look for any clues for weakness in the trend. It is very hard to spot a market top during this phase.
Bear Market: A bear market is typically defined as a time where stock prices fall 20% of more from recent highs. There maybe notable negative investor sentiment towards the market. The last time the US had a prolonged bear market was between 2007-2009. The S&P 500 Lost 50% of its value during that time.
Bear Market Phases
Denial Phase: The market (this can be for a commodity market, bond market, stock market, etc.) may drop 7 -14% as an example. Market participants may remain optimistic and only view this pullback as a short term pullback and a buying opportunity. News can remain positive and negative. The negative news is perhaps downplayed or ignored. Investors are eager to buy the pullback.
Concern Phase: The market is not making higher highs anymore; in fact it is making lower highs and there is no new all time high. News worsens and investors begin to worry and show concern. Investors start to take their profits or cut their losses with some buying more and more – hoping that the pullback is only temporary. News worsens and worsens and people begin to get out of the market. Investors turn pessimistic.
Capitulation Phase: This is the final phase of the bear market. It may seem like the world is coming to an end for whatever market is in this phase. If this is a stock market capitulation phase, bad news is constant and everyone is experiencing fear. Valuations are at multiyear lows and sharp price declines are becoming the norm. Markets tend to move down a lot faster than they go up! This is time where, unfortunately, many people sell at the bottom. They just cannot take it anymore and have to get out. Everyone runs for the door at once and pushes the prices down to what seem like crazy lows. It is around this time where the smart money comes back into the market looking for value and slowly being to build positions as a new bull market may be on the horizon soon…and on and on the cycle goes!
This content is for informational purposes only. You should not construe any such information or other material as investment, financial, or other advice. Nothing contained on this article constitutes a recommendation, endorsement to buy or sell any securities. Any references to any particular securities is for example and informational purposes only. Seek a licensed professional for investment advice. Information in this article has been obtained from sources believed to be reliable, but its accuracy, completeness, and interpretation are not guaranteed.