Figuring out how to profit from the stock market depends on 3 key questions: when to buy, when to sell, and when to hold on for juuust a little longer. It’s crucial to understand that simply selling at a profit is always more important than buying and selling at the absolute bottom and top, respectively.
How to profit from stocks?
Timing is important, but it’s not everything
We aren’t pros who can spend the entire day obsessing over flashing numbers and screaming “SELL, SELL, SELL!” over the phone, like in the movies. We’re normal people living normal lives, investing for the long term.
You might just need to check and update your portfolio once per quarter. The only ‘timing’ you should worry about is getting started ASAP, as portfolios provide higher returns the longer they’re invested.
(Excessive) greed will be your downfall
On the other side of the coin to maximizing profit is minimising risk. You want to protect what you’ve already gained and shield yourself from losing big time.
Your emotions often overcome rational judgment, but there are techniques to help you counter human nature and sell a good stock before it takes a sudden nosedive or cut off a bad stock that will never regain value.
When to BUY a stock
The volatility of the market makes it very important to have your personal finances in order before making your first stock investment. If you are struggling with large debts or don’t have an emergency fund yet, then it’s best to revisit stocks another time.
Determine the why and how
Beginners often start their trading journeys by immediately wondering what stocks to buy, but there are other important questions to ask before contacting a broker or clicking ‘buy,’ like:
- What goals do you want to achieve?
- How much money can you invest?
- Are you planning for the short or long term?
- How much risk are you comfortable with?
- How hands-on would you be?
Knowing the answers can help provide clarity on your goals and guide your strategies. If you’re risk-averse, then stick to stable, more established companies. If you’re only looking for short-term gains, then it’s probably smarter to invest in a high-interest savings account. The degree of effort and time you are willing to give affects the size and diversity of your portfolio.
Invest in businesses familiar to you
During the cryptocurrency craze in 2017, the stock value of the Long Island Iced Tea Company jumped 500% after it changed its name to the Long Blockchain Company. Blockchain was then the rage in business and technology, so people happily hopped aboard despite the fact that they didn’t completely understand what blockchain was and the company didn’t have technology assets. Less than a year later, the Nasdaq delisted the company, which also found itself under investigation by the SEC and abandoned both its beverage business and future blockchain plans.
What this anecdote shows is that you shouldn’t invest in a company that you aren’t familiar with or whose activities you can’t sum up in two simple sentences. When selecting companies to invest in, avoid the bandwagon and choose the ones that you trust as a consumer and whose business model you understand.
Good companies aren’t necessarily good stock
The easiest tip for novice investors is to browse through publicly-available information on the company. Have revenue numbers been stable or growing over the last year? Are they continuing to develop products to keep up with (or stay ahead of) competitors? Is the company in the news for positive or negative reasons? If there is any reason to doubt becoming a part-owner of that company, then it’s best to cross it off and move to the next one on your list.
Something about ‘eggs and baskets’…
One key to managing risk and ensuring gains is diversification. The general advice among experts is to:
- Avoid letting a single stock occupy a disproportionate slice of your portfolio. 5-20% is advised as the maximum percentage of your investments a single company should occupy.
- Invest in companies spread across different industries, try to spread out your options.
When to SELL a stock
You can hold on to stock for as long as you want, but you’ll never actually realize a profit (or loss) until you sell it. Having said that, selling should be a rare occurrence on a new portfolio due to the commissions and transaction fees charged by brokers.
The stock hits your price targets
When buying a stock, define a certain price or realistic range at which you’d consider selling, depending on your analysis of its growth potential or limitations. This isn’t a hard and fast rule, however. You might be comfortable sitting back as a stock slowly gains value, or rethink your time horizon and sell in favor of a rapidly-growing competitor.
Advisers recommend ‘locking in’ profits on rising stocks by selling once they reach a certain value, and then shifting focus to the next opportunity. On the other end of the spectrum is your ‘red line,’ or price range at which you’d sell a losing stock, absorbing an acceptable loss rather than risk losing a larger amount as it continues to decline in value.
Sudden changes within the business
Aside from passively observing how a stock’s value performs in relation to targets, it’s also worth analyzing the underlying business. A slump in traditional metrics, such as sales, profits, and cash flows, can foreshadow a decline in value. News of financial fraud, operational irregularities, mass layoffs or cost-cutting, organizational restructuring, mergers, or bankruptcy, all have the tendency to tank confidence and drive stock down.
Since each business is built differently, a dip in quarterly sales doesn’t necessarily mark a long trend in reduced demand or increased competition, just as restructuring may be taken a positive sign of the business enforcing better control over itself.
You need a medium-term cash infusion
Planning to buy a house, expecting a baby, or paying for college within the next 3 years? Stock is a liquid asset that can be sold for cash at any time, even for short-term emergencies.
Even if your stocks are doing well, you could consider selling off some (or all!) of your stocks and keep the cash shielded from drops in the market in savings accounts or shorter-term investments.
That said, we recommend already having an emergency fund worth around 3 to 6 months of expenses stashed in a savings account before getting started with stocks.
The bottom line
Stock trading always carries an element of risk and will never be ideal for meeting short-term financial goals, but patient and prudent investors are bound to see gains over longer periods of time, with overall market growth and diversification absorbing shocks.
So keep updated on news, do your homework, and don’t be greedy. The stock market may be a complicated creature, but you (yes, you!) have what it takes to tame it.