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How to Understand the Stock Market and Invest with a Brokerage Account

By Edited May 11, 2015 7 4
What is a Brokerage Account
Credit: mjpyro

Recently I was watching the nightly news with a family member and the usual Dow Jones daily results were mentioned by the anchor. She commented that she didn’t understand any of that.

The stock market can be a confusing place for a lot of people, but it should not be. At its core, it is simply assets,stocks or bonds, being priced by the market which determines their value. That does not mean the market always gets it right. Bubbles in asset prices will develop, but over time, a stock price will settle at its fair value.

What does that mean to you?

Well, the stock market and investing is nothing to be feared. If you understand what is going on, then investing can be a very rewarding experience, however, you should never approach it as a get-rich-quick scheme. It hardly ever works out that way. You should look for annual gains above the rate of inflation and anything over that should be considered a bonus. Setting low expectations with your market gains, as with your writing online for money, will serve you best in the long run. As the saying goes, under promise and over deliver in life. Take that same approach in your attitude regarding investing.

First, a little education.

What is the Dow Jones?

Simply put, it is an average of 30 stocks that are deemed to represent the majority of American industry.[1] The list of 30 stocks are updated periodically by Dow Jones in New York City to reflect the new economy.

Often times though, being placed in the Dow 30 is a curse for a stock price because it is recognition by the market that the high growth rates of the company are over.

Some of the more recent examples of this was when Microsoft and Intel were placed in the Dow 30 in the late 90s. Their stocks have languished for over a decade now. Microsoft has shown some life recently, but for shareholders, the wait has been painful has they languished for years in dead money. There has been rumors that the Dow will add Apple at some point, which makes Apple shareholders cringe. It is sort of like when a band releases a greatest hits album. They are essentially saying, that’s it, we are tapped out.

Without getting extremely technical, the Dow Jones Industrial Average is a price weighted average of those 30 stocks. It does not represent the average of stock prices for those stocks in the Dow, rather it is the sum divided by a predetermined divisor which accounts for stock splits and dividends paid out over the years.

The NASDAQ and S&P 500 also offer similar averages to gauge the markets. So when you hear that the Dow or NASDAQ was up or down on any given day, understand that they are simply referring to those averages that are used to help gauge the current state of the stock market. Just because any of those averages are up or down does not necessarily mean your favorite stock was up or down.

How to Invest in the Stock Market

Stock Market Trading for Beginners

By now you probably already know about investing in the stock market through your company sponsored 401K plan. That approach is relatively painless and offers options to diversify your risk enabling you to have exposure to a wide segment of the economy based on your choices.

401k plans also offer tax savings and usually some sort of company matching which make them a very good deal for any professional. If you have this option at work, do not overlook it.

Other Ways to Invest Directly

If you are interested in investing outside your 401k, you can open mutual funds through large companies like Vanguard or Fidelity Brokerage. For a small commission, they will manage your money in the choices you select. If you are inexperienced or have fear of the market, this is probably your best route if you want to invest outside of your 401k.

However, there is a more direct method to invest and that requires a brokerage account with one of the large national companies like E*trade, Ameritrade or Charles Schwab. There are many others to choose from and each offer pros and cons based on the type of trader you want to be. If you are looking for the cheapest online brokerage account, you have that option, or if you want access to professional advice, there are other options.

I am not recommending one brokerage service over another. That is for you to decide, however, I will say that initially I started with Ameritrade a decade ago, but migrated to E*trade about seven years ago and have been with them ever since. They do not have the lowest commissions in the industry, but they have other options such as other types of banking accounts and free Market Pro trading software, and the Etrade customer service is pretty good.

Once you have an interactive brokers account, you will be able to invest in individual stocks like Apple or Netflix. Each trade will cost between $7 and $20 depending on the company you go with. Some even offer mutual funds and no-fee IRAs through their service so there are a lot of options for investing outside of the traditional employer 401K.

How to Open a Brokerage Account

Etrade Customer Service
Credit: Own Oil Industry News via Wikimedia Commons

Low cost brokerage accounts offer the same basic service and you will need to apply for an account online on their website. The process is relatively painless and does not require a step-by-step walk-through for the purposes of this article. Just go to any of the websites and look for the “Open an Account” button and follow the prompts. It will ask for some basic identification information as well as your social security number. Why?

Well, first of all, they will check your credit before allowing you to open an account, but more importantly, they will need it to file any gains you have with the IRS.

Therefore, do not be alarmed by giving your social security number to one of these websites. It is normal and necessary.

Funding the Account

During the application process, you will be asked how you intend to fund the account. Typically they ask that you set up an electronic fund transfer (EFT) with your regular bank account. Again, do not be alarmed by this. Once the account is approved, they will sweep the specified amount from your Wells Fargo or Suntrust account into the new brokerage account and the money is available for immediate trading.

If the idea of connecting these accounts makes you uncomfortable, then you can fund your account with a check, however, it will take longer for the new account to be set up.

However, consider linking the account with the EFT feature because it will allow you to move money around freely. I personally do this all of the time without issue or incidence.

Open a Brokerage Account

Margin Account - What is it and Do I Need it?

During the online application process, you will be asked if you would like to open a margin account. The short answer is no, do not do it.

So what is it?

A margin account allows you to buy stock on credit based on how much capital you have in your account. So if you had $10,000, generally you would be able to buy another $10,000 worth of stock on margin, although it depends on the type of stock. If it is a large cap, stable stock like Apple, you will generally be able to buy 50% more stock on margin.

If it is a volatile stock or with a small market cap, the amount you are allowed to buy on margin is reduced.

Margin is simply a sanitized word the industry came up with for credit. You are basically charging stock on credit, for a fee of course. Margin accounts have an APR.

What is APR?

Well, think of it the same way your credit card company charges you interest on daily outstanding balances. That daily rate is calculated as an annual percentage rate. Margin accounts work the same way. You are charged for every day you own the stock on margin.

My recommendation is to avoid this option. You can get into a lot of trouble by over buying, and when the market turns and goes down, then your losses are doubled. At that point, you can either sell at a loss or you will receive a margin call requesting that you add more money to your account, of the firm will forcibly liquidate some of your holdings to cover losses.

What is a Margin Account

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What Are Stock Options and Do I Need Them?

The other choice you will need to make when signing up for a brokerage account is whether or not you would like to trade in options.

Stock options allow you to own stocks at lower risks. They can also be used to hedge your bets on stocks you own outright. 

Initially, I would recommend that you skip this option unless you are an experienced trader. You can always add it later at any time.

Final Thoughts

How to Invest in the Stock Market
Credit: mjpyro

An online brokerage account allows you to invest directly into the stock market today. There are many types of options available when applying online, so do your research and jump in slowly.There are even virtual stock trading accounts that you can use to practice fantasy trading to see how you do initially.

But if you are ready for a real account, my recommendation is that you only fund it with $1000 initially until you get comfortable with trading online. Become familiar with stock charts and market research and terms such as Price/Earnings Ratio and market capitalization.

You can also use these types of account to create traditional IRA account and Roth IRA accounts which allow you to invest directly in specific stocks.

Finally, some full service brokers allow you to set up a custodial account as a trust for your children.

After doing your research, follow through online and start trading slowly until you gain the experience you need. Markets do not always go up, but there is no reason to be afraid of investing intelligently in the market.

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Comments

Sep 8, 2014 7:27pm
Joey_Batz
Great article. Good to see a fellow investor here. People should be knowledgeable on how to invest in this day and age.
Sep 28, 2014 9:19am
investmentcollege
I totally agree Joey. It's discouraging how many people don't know about investing nowadays.
Sep 28, 2014 9:19am
investmentcollege
I totally agree Joey. It's discouraging how many people don't know about investing nowadays.
Feb 22, 2015 5:15pm
pashii
Good basic information for novice investors.
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Bibliography

  1. "Dow Jones Industrial Average - DJIA." Investopedia. 18/11/2014 <Web >

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