August 15, 2011 | In: General
How Can Stocks Make You Money?
When I first started this website, I had one aim, I wanted to create articles about stocks that anyone can understand. I wanted to simplify all the concepts of stocks and stock trading to people who have never traded stocks. Stock trading is exciting, fun, and lucrative (but can be very stressful), and is not gambling, and my aim is to always pass this message to my readers.
Now many people who have never ever made a trade (in the stock market) in their lives ask a question that might seem very obvious to us, “how can stocks make you money?”.
Well, there are four ways that stocks can make you money:
- Dividends: Some companies offer dividends to their stockholders (people who own shares from their companies). Dividends typically (but not always) reflect the performance of the company, and some of the best performing companies offer 4% to 5% a year in dividends, which is better than the interest rate on a fixed term savings account in the bank (I think these days banks give you something less than 1% on your money). An example of a stock giving you 4% a year is RY (Royal Bank of Canada), RY gives 50 cents every quarter, and the stock is around $50 (so you get 1% of your investment every 3 months, which you can re-invest to buy even more RY!). You have to be careful from companies offering very high dividends, which may be a sign of an underperforming stock. Note that there are some great stocks, such as AAPL (well, it’s great at least for now) that do not offer dividends.
- Stocks going up in price and you selling at the right time to make a profit: Good stocks generally go up on the long term. Some have spikes in very short periods (for example, 20% or 30% increase in a few days), and some go up 5% in the whole year. Now when your stock is up, you can sell your shares in the market and make a profit, but this will forfeit your future dividends, because you will no longer be a stockholder of the company. This is a two edged sword though, as stocks can also go down. Take a look at BAC, the stock of Bank of America, which is one of the biggest banks in the US, the stock went down 46% so far this year. If you want to make money by selling stocks you have to 1) buy stocks in the right industry that is not facing long term troubles and 2) choose the right timing and 3) keep a close eye on your stocks and 4) be patient and 5) never ever be greedy!
- Options: Options are advanced tools to make money from stock trading. The main power of options is leverage. An option gives you the right to buy/sell stocks at a certain price before a certain date (but note that you’re not obliged to buy/sell the stock). I will discuss options in details in another article (this topic is advanced, and as new investor, I think you should worry first about trading equities).
- Shorting stocks: An introduction to shorting stocks is available here. Generally, the basic idea of shorting is borrowing shares of a certain stock from your broker, sell them in the market immediately, wait for the stock to go down in price, buy the shares again, and then return to them to your broker. Your profit will be the difference between the price when you first sold the stock and that when you bought it. So, shorting stocks means that you will make money when a stock goes down, instead of making money when a stock goes up. Not all stocks can be shorted, and your broker usually demands that you have something called a margin account in order to short stocks. Shorting stocks is controversial, and similarly to options, is also used by advanced investors.