Moneyzine
/Investment Guides /Successful Stock Investing

Successful Stock Investing

Moneyzine Editor
Author: 
Moneyzine Editor
9 mins
September 21st, 2023
Advertiser Disclosure

Investing in the stock market is both a rewarding as well as risky proposition. Many investors are quite comfortable knowing their mutual funds are professionally managed, and the diversification of those portfolios has kept risk to a minimum. For other investors, selecting individual stocks provides both a sense of control and satisfaction.

In this article, we are going to cover some of the keys to successful stock market investing. That discussion will include how to go about researching companies, as well as a primer on stock trading terms and financial ratios. We're also going to explain how risk and reward are determined by market forces, and the effect price volatility can have on some investors. Finally, we'll talk about setting goals and how they can be used to figure out if it is the right time to sell stocks.

Buying Stocks

The approach to buying stock in a company should be the same as that used for any other purchase of this magnitude. Most consumers wouldn't think of spending $5,000 without thoroughly researching the product or service they're thinking about buying. The same thought process should apply to common stocks.

Researching Companies

We've written extensively on the topic of researching stocks elsewhere in this publication. In this article, we're going to cover the basics. Whenever someone buys common stock in a company, they're becoming a part owner of the business. For that reason, investors need to think like a business owner when evaluating each company.

Thinking like a business owner entails finding companies that are considered leaders in their industry, demonstrate superior brand loyalty, or have some other competitive edge. Strong brand names such as Coca Cola or Starbucks can usually demand a premium price for their products, and that translates into higher profit margins.

Understanding Financial Ratios

One of the fundamental ways to gain a better understanding of the financial well-being of a company is by examining their financial ratios. Here there is almost an endless list of possible measures from which to choose and we provide more guidance on this topic in our article: Understanding Financial Ratios.

Here we're going to limit the discussion to four principal areas: price, profitability, financial condition, and investment return. Explanations for each of these critical ratios appear below:

  • Price / Earnings Ratio: Also referred to as the P/E ratio, this measure is calculated by taking the stock's price and dividing it by the latest 12 months of earnings per share. The P/E ratio is an indicator of the premium paid for a stock, and is an indicator of the market's view of future growth potential. Higher ratios indicating higher premiums.

  • Net Profit Margin (%): This is the ratio of net profits to sales. This is arguably the best indicator of the company's efficiency because net profit takes into consideration all expenses of the company. The net profit margin of stocks being considered should be high relative to their competitors or industry.

  • Debt / Equity Ratio: This is a measure of long-term debt divided by common stock equity. This financial ratio is a measure of leverage. The lower the debt to equity ratio, the less likely a company will be affected by a downturn in the economy.

  • Interest Coverage: This measure is calculated by taking a company's latest 12 months' earnings before interest and taxes (EBIT) and dividing it by the latest 12 months' interest expense. Interest coverage tells the analyst how easily a company can handle its debt service. The higher the interest coverage value, the easier it is for the company to pay back its debt.

  • Return on Equity: Also referred to as ROE, this ratio is calculated by taking the latest 12 months' net income and dividing it by common stock equity. The return on equity ratio is perhaps the most widely used, and most valuable, measure of how well a company is performing for its shareholders. The higher a company's return on equity, the better the company is performing.

Common Stock Trading Terms

While buying and selling shares of stock is a relatively simple process, the industry is full of unfamiliar sounding jargon. Before thinking about trading stocks for the first time, it's important to understand the fundamentals. Listed below are the most common trading terms used today:

Market Order

A market order is used to buy or sell a stock as quickly as possible at the prevailing price when the buy order reaches the marketplace. A market order guarantees a transaction will occur, but does not guarantee the price paid, or received, for the securities.

Limit Order

A limit order is used to buy or sell a stock only at a price specified (also known as the limit) or at a better price. With a limit order, there is no guarantee that a transaction will occur. But if it does, then the price will be better than the one set by the trader.

Stop Order or Stop Loss Order

A stop loss order is used to sell a stock once the market price has reached a stop price, which is set below the current market price. Stop orders are used to protect a gain, or prevent further loss on an investment.

Stop Limit Orders

A stop limit order is used to sell a security at a specified price, or better, after a stop price has been reached. A stop limit order identifies the minimum price an investor is willing to accept for the stock they own. There are two parts to a stop limit order: the stop price and the limit price.

Once a stock's price moves through the stop price, the trade then becomes a limit order. For this reason, there is no guarantee that a stop limit order will be filled, since the stock can trade through the limit price before the order is executed.

Market Risks and Rewards

Risk and reward often go hand-in-hand. It's possible to eliminate all the risk of losing money (preserve capital) by placing money in a steel safe. But even under these circumstances, inflation will erode the buying power of that money over time. While buying stocks entails greater risk, the potential rewards are greater too.

Smart investors want to maximize the returns they're achieving at any given level of risk. Thankfully, there are several ways to minimize the risks associated with owning stocks. Earlier we talked about researching companies before buying, and that's a great way to help minimize risk

Diversifying a portfolio is a second way to minimize risk. By holding a portfolio of stocks, it's possible to eliminate the risk associated with any single company underperforming versus market expectations. While the entire market is still at the mercy of macroeconomic factors, diversification allows investors to eliminate the risk associated with holding stock in just one company. Most experts agree an investor needs shares of six to ten companies to create a diverse portfolio.

Price Volatility

Some stock prices are more volatile than others. By this we mean the stock of some companies will experience price swings, both up and down, that are extreme when compared to the overall market. The most common measure of relative price volatility is a stock beta. This value is commonly published along with the ratios mentioned earlier. When evaluating relative volatility, there are only two rules to remember:

If the stock's price experiences movements that are more volatile than the stock market, then the beta value will be greater than 1. If a stock's price swings are less than those of the market, then the beta value will be less than 1.

Investors react to price swings differently. What's important to avoid is buying a stock then selling it because a drop in price is worrisome. Our risk tolerance calculator helps individuals understand their ability to avoid panic-selling when these price swings occur.

Knowing When to Sell Stocks

Whenever anyone buys a stock, they should also be thinking about the best time to sell. This is oftentimes referred to as an exit strategy. For some investors, knowing when to sell a stock is a twofold decision that involves targets:

  • Price Increases: setting a target price at which point they're willing to lock-in their profits and sell the stock.

  • Price Decreases: if the stock starts to falter, the investor should have a price point in mind to limit their losses and sell the stock.

Another approach is to ignore the target price theory altogether and simply hold onto a stock as long as it's performing as expected. When a stock's price appreciation is no longer meeting expectations, then it's time to sell that stock and lock in a gain.

Selling Stocks and Income Taxes

Finally, everyone should understand the income taxconsequences of investing in the stock market in terms of capital gains. The American Taxpayer Relief Act of 2012 made several important changes to the treatment of long-term capital gains. Individuals in the 10% and 15% federal income tax brackets pay 0%, while those in the 39.6% bracket pay 20%; all other taxpayers owe 15%. Short-term capital gains are taxed at an individual's "normal" incremental tax rate.


About the Author - Successful Stock Investing


Explore Investing Further

Trading has never been easier, thanks to the rise of online platforms that enable you to buy and sell various assets at the click of a button. But with so many options available, it can be challenging to decide which platform is right for you.
Looking for a way to avoid swap fees while trading forex?
Below listed are the small reviews of the top 10 ETF brokers available across the United States.
Our top beginner's pick for copy trading is eToro. Read on for more details, plus seven good alternatives.
Swing trading stocks can be a great way for investors to take advantage of short-term stock market movements and gain significant returns. If you're interested in swing trading, the key to success lies in selecting the right stocks to buy and sell quickly for a profit.
The table below lists the best stock picks under $2, listed on public exchanges.
The table below lists the best stock picks under $1, listed both on public and OTC exchanges.
This section will highlight the best EV-trading penny stocks available in the United States.
The demand for sustainable energy has grown rapidly in recent years. This has resulted in increased scrutiny of the automotive market. As a result, the electric vehicle (EV) industry has made significant advancements.
Intelligent Bio Solutions Inc. is a life sciences company, founded in 2016 with headquarters in New York and is engaged in performing diagnostic tests, real-time monitoring, and non-invasive surgery for its patients. The firm has developed a CoV-2 Biosensor, which can be used in RNA virus detection.
Hour Loop was founded in 2013 with headquarters in Redmond, Washington. It’s an online retailer involved in e-commerce in the United States that hit the public markets on Jan 7th of 2022. The company sells home/garden decor, electronic products, kitchenware, and apparel through walmart.com, amazon.com, and hourloop.com.

Related Content

Are You a Financial Disaster? The Real State of Your Finances
Have you ever heard the saying, “If you don’t have a goal, then you’ll wind up hitting it with amazing accuracy.”? In other words, if you have no idea where you want to be in your future life, then it really doesn’t matter what you do because wherever you end up will match your goal…which apparently was never important enough for you to think about in the first place.
March 13th, 2024
DRIP Brokers: Best Brokers for Dividend Investing for March 2024
Reinvesting dividends could mean compound growth for your portfolio. But reinvesting them manually can be a hassle. This is why you could benefit from a dividend reinvestment plan (DRIP).
March 12th, 2024
11 Steps to Transform Your Finances (For Good This Time!!)
The money comes in…the money goes out…and at the end of each month you have very little to show for all your efforts. Then, after buckling down for a bit and saving here and there, it feels like you’ve gained a little traction…until another unexpected bill comes along and takes your bank account down to nothing (or probably more likely, racks your credit card back up to the max instead of down to zero like you were fighting for). It’s time to change this. Now is the time to transform your finances.
March 11th, 2024
How To Invest in Real Estate Without Becoming a Landlord
We all know that in order to build wealth and prepare for retirement, investing is the key. However, it can be hard to figure out what to invest in and how to put your money to good use. One of the most talked about ways to build wealth is owning property and being a landlord to bring in passive income. But what if you don’t want to do that? You can still invest in real estate!
March 6th, 2024
Investing In Nature: The Closest You'll Get To Your Money Growing On Trees
ESG (Environmental, Social, and Governance) has become a polluted word for many traders and investors - but that doesn't mean it's going completely away. Nor does that mean you can't profit from nature or sustainable practices. But there are some opportunities in the regenerative ag, conservation, and green real estate spaces.
February 29th, 2024

Contributors

Moneyzine 2024. All Rights Reserved.