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Soon I will be coming into a bit of extra money. Rather than simply sticking it in a savings account I would like to make my money work for me and getting into stock seems to be a good way to do that.

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    As Mark Twain said: the way to make money in stocks is to buy a good stock, and when it goes up, sell it; if it doesn't go up, don't buy it. – Pete Becker Feb 5 '15 at 21:52
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    Be careful! Many answers are explaining "how is money made in the stock market? How does it work?" since you did ask that in your title. But what you need to know is really "What is the best way for me to get started with investing?" See @Brythan's answer for that. If you are asking how the stock market works, you are not knowledgable enough to safely invest in it. Look into mutual funds. Talk to your elders, and talk to a bank. – Moby Disk Feb 6 '15 at 20:07
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This is a very good question!

The biggest difference is that when you put money in a savings bank you are a lender that is protected by the government, and when you buy stocks you become an owner.

As a lender, whether the bank makes or loses money on the loans it makes, they still maintain your balance and pay you interest, and your principal balance is guaranteed by the government (in the USA). The bank is the party that is primarily at risk if their business does not perform well.

As an owner, you participate fully in the company's gains and losses, but you also put your money at risk, since if the company loses money, you do too. Because of this, many people prefer to buy funds made up of many stocks, so they are not at risk of one company performing very poorly or going bankrupt. When you buy stock you become a part owner and share in the profitability of the company, often through a dividend.

You should also be aware that stocks often have years where they do very poorly as well as years when they do very well. However, over a long period of time (10 years or more), they have historically done better in outpacing inflation than any other type of investment. For this reason, I would recommend that you only invest in the stock market if you expect to be able to leave the money there for 10 years or more, ideally, and for 5 years at the very least. Otherwise, you may need to take the money out at a bad time.

I would also recommend that you only invest in stocks if you already have an emergency fund, and don't have consumer debt. There isn't much point in putting your money at risk to get a return if you can get a risk-free return by paying off debt, or if you would have to pull your money back out if your car broke down or you lost your job.

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    @Michael I agree that it will affect share price, but as you point out, lots of things can, so I don't think it's fair to call it a 'direct' participation. The company could make money and the stock could still go down, for instance. – DA. Feb 5 '15 at 19:28
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    @JAGAnalyst - do you know that someone can still lose money holding stocks for 10 years or more. And one can make money in holding stocks as little as one day or less. You just have to sell higher than you buy to make money. You answer is very biased and not based on facts. – user9822 Feb 5 '15 at 21:29
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    @corsiKa, are you saying that if I buy a stock or even an Index ETF and I sell it in exactly 10 year time, I would be guaranteed to make a profit? – user9822 Feb 6 '15 at 1:16
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    I could show you many stocks and many indexes that have gone nowhere over a 10 year period and others that are lower than 10 years before. – user9822 Feb 6 '15 at 1:21
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    @corsiKa, most long term investors rely purely on luck to make any money, and many lose money, why? Because they haven't got a written investment plan. I know many long term investors who had to delay their retirements because they were holding for the long term and lost half their capital during the GFC. – user9822 Feb 6 '15 at 20:26
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You can make money via stocks in two primary ways:

  • you sell your stock for more money then you paid for it.
  • said stock you purchased pays out a dividend (only some do).

Note that there's no guarantee of either. So it may very well not make you money.

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    +1, this is the best answer, sweet and short and gets to the point and actually directly answers the question. – user9822 Feb 5 '15 at 20:23
  • Another method, which can take a while to understand, is "short selling". Basically, you sell shares you don't actually own - yet. Eventually, you have to "balance the books" and buy those shares you've been selling. PROVIDED the actual value of the shares has gone DOWN in the meantime, you make a profit. Got it wrong? You could lose a fortune [how much you lose depends on how much the shares went UP]. – Alan Campbell Feb 6 '15 at 7:47
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    @AlanCampbell But then you don't deal in stocks, for the most part. It seems more natural to think of this as one type of derivative among many rather than as a way to make money on the stock market. – Relaxed Feb 6 '15 at 15:39
  • ("then" -> "than". E.g. ref. <wikihow.com/Use-Than-and-Then>.) – Peter Mortensen Feb 6 '15 at 15:43
  • to the point but I would like to make first point bit more strict, "you sell your stock for more money then you paid for it within reasonable time so inflation does not erase your gain." – pinkal vansia Feb 8 '15 at 5:28
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If you have money and may need to access it at any time, you should put it in a savings account. It won't return much interest, but it will return some and it is easily accessible.

If you have all your emergency savings that you need (at least six months of income), buy index-based mutual funds. These should invest in a broad range of securities including both stocks and bonds (three dollars in stocks for every dollar in bonds) so as to be robust in the face of market shifts.

You should not buy individual stocks unless you have enough money to buy a lot of them in different industries. Thirty different stocks is a minimum for a diversified portfolio, and you really should be looking at more like a hundred. There's also considerable research effort required to verify that the stocks are good buys. For most people, this is too much work. For most people, broad-based index funds are better purchases. You don't have as much upside, but you also are much less likely to find yourself holding worthless paper.

If you do buy stocks, look for ones where you know something about them. For example, if you've been to a restaurant chain with a recent IPO that really wowed you with their food and service, consider investing. But do your research, so that you don't get caught buying after everyone else has already overbid the price. The time to buy is right before everyone else notices how great they are, not after.

Some people benefit from joining investment clubs with others with similar incomes and goals. That way you can share some of the research duties. Also, you can get other opinions before buying, which can restrain risky impulse buys.

Just to reiterate, I would recommend sticking to mutual funds and saving accounts for most investors. Only make the move into individual stocks if you're willing to be serious about it. There's considerable work involved. And don't forget diversification. You want to have stocks that benefit regardless of what the overall economy does. Some stocks should benefit from lower oil prices while others benefit from higher prices. You want to have both types so as not to be caught flat-footed when prices move.

There are much more experienced people trying to guess market directions. If your strategy relies on outperforming them, it has a high chance of failure. Index-based mutual funds allow you to share the diversification burden with others. Since the market almost always goes up in the long term, a fund that mimics the market is much safer than any individual security can be. Maintaining a three to one balance in stocks to bonds also helps as they tend to move in opposite directions. I.e. stocks tend to be good when bonds are weak and vice versa.

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    "It won't return much interest, but it will return some". True, but note it will almost certainly return less than inflation, which means, practically, it returns negative interest. – ChrisInEdmonton Feb 6 '15 at 13:12
  • I disagree with using a savings account for more than a month or so of expenses. Put the 6 months in a low to moderate risk income fund (which will have a lot of bonds, T-bills, and so on). – jamesqf Feb 6 '15 at 18:50
  • what are mutual funds and why are they better for a starting investor? – Trismegistus Feb 6 '15 at 20:24
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    @Trismegistus A mutual fund is an investment vehicle that itself invests in stocks and bonds. It's better for small investments both because it is diversified and because the research requirements are less. Index funds invest in all the stocks in an index (e.g. Dow Jones, S&P 500, etc.), so they make money if the market does. – Brythan Feb 6 '15 at 22:11
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If you buy a stock and it goes up, you can sell it and make money. But if you buy a stock and it goes down, you can lose money.

2

Generally, a share of stock entitles the owner to all future per-share dividends paid by the company, plus a fraction of the company's assets net value in the event of liquidation. If one knew in advance the time and value of all such payouts, the value of the stock should equal the present cash value of that payout stream, which would in turn be the sum of the cash values of all the individual payouts.

As time goes by, the present cash value of each upcoming payout will increase until such time as it is actually paid, whereupon it will cease to contribute to the stock's value.

Because people are not clairvoyant, they generally don't know exactly what future payouts a stock is going to make. A sane price for a stock, however, may be assigned by estimating the present cash value of its future payments. If unfolding events would cause a reasonable person to revise estimates of future payments upward, the price of the stock should increase. If events cause estimates to be revised downward, the price should fall.

In a sane marketplace, if the price of a stock is below people's estimates of its payouts' current cash value, people should buy the stock and push the price upward. If it is above people's estimates, they should sell the stock and push the price downward. Note that in a sane marketplace, rising prices are a red-flag indicator for people to stop buying. Unfortunately, sometimes bulls see a red flag as a signal to charge ahead. When that happens, prices may soar through the roof, but it's important to note that the value of the stock will still be the present cash value of its future payouts. If that value is $10/share, someone who buys a share for $50 basically gives the seller $40 that he was not entitled to, and which the buyer will never get back. The buyer might manage to convince someone else to pay him $60 for the share, but that simply means the new buyer is giving the the previous one $50 that he wasn't entitled to either. If the price falls back to $10, calling that fall a "market correction" wouldn't be a euphemism, but rather state a fact: the share was worth $10 before people sold it for crazy prices, and still worth $10 afterward. It was the market price that was in error.

The important thing to focus on as a sane investor is what the stock is actually going to pay out in relation to what you put in. It's not necessary to look only at present price/earnings ratios, since some stocks may pay little or nothing today but pay handsomely next year. What's important, however, is that there be a reasonable likelihood that in the foreseeable future the stock will pay dividends sufficient to justify its cost.

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    I think the statement about the seller getting money they aren't entitled to is a bit misleading, because there is always uncertainty about what the NPV of future payments are. Often even small changes in initial assumptions can lead to wildly varying prices, each of which is perfectly valid if those assumptions turns out to be correct. – Michael Feb 5 '15 at 19:32
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    @Michael: My point about "not entitled to" was not intended to imply any moral deficiency on the part of the seller. My point was that if the seller were "entitled" to that $40, then someone who satisfied that entitlement might in return be entitled to expect some repayment of that $40. My point was that the buyer should be viewed as simply having thrown $40 away, and nobody should feel any obligation to see that he gets one dime of it back. – supercat Feb 5 '15 at 20:06
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    As people are not clairvoyant and don't know what the future payment of a company are going to be, any estimate would be based on cirtain assumptions and the person's biases. As we all have different biases we will all make different assumption and value the stock value at different price. So stock valuation is a guestimate at best. – user9822 Feb 5 '15 at 20:33
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    @supercat,the reason they don't sell fast enough is because they get emotional about the stock, they think the price will come back up, but in most cases it does't. When buying a stock you should have your sell criteria worked out before you even place your buy order into the market. You sell order should also be placed into the market at the same time you place your buy order, this eliminates your emotions sabotaging the trade. – user9822 Feb 6 '15 at 1:39
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    @MarkDoony: If non-speculators are only willing to pay $10/share for a stock but speculators bid the price up to $50, even computers processing stop-loss orders (which are about as emotionless as one can get) won't be able to sell fast enough to get more than $10/share if the supply of speculators dries up. – supercat Feb 6 '15 at 14:47

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