How the Stock Market Works: Investment Advice for Beginners

Beginning investors are lured to the stock market in the hopes of generating massive profits without working.

People starting out make many of the same mistakes, primarily by not understanding how the stock market works.

New stock market traders chase after hot stocks, buy on margin, and sell stocks at the wrong time.

Although all investors make mistakes, inexperienced investors often trade their way into large losses through a lack of discipline and the desire for a quick score.

The Stock Market is a Big Auction

Many beginning investors think of the market as a game or sports event. The language used perpetuates this tendency.

Stocks are winners, and traders try to hit home runs. Traders need to think of the market as one big auction with many items.

Every time someone buys a stock, there is someone else who is selling.

If a trader believes that a stock has to go up, his opposite number is selling because he thinks the stock has nowhere to go but down.

The key to making money in the market is to understand that the stock prices move because of buying and selling. Stocks don’t go up because people like them.

Stocks go up because someone is willing to bid more for a stock than the last person did. They go down because someone is willing to sell for a lower price than the previous guy.

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Chasing After Hot Stocks

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chasing after stock. credit - shutterstock

New investors often base an investment decision on what happened to the stock in the past, rather than what is going to happen. Traders make two major kinds of mistakes:

Newbies buy too late when a stock is going up. A stock will increase in price suddenly, known as a “gap up.” When this happens, message boards for the stock will be filled with new buyers.

Then the stock will begin to drop, as those we owned the stock prior to jump “take profits,” that is, sell the stock. Those new buyers will often comment. “The stock just had good news, why is it going down?” or “why isn’t it going up?”

The reason is that the good news has already been factored into the new price. It will require additional good news for people to pay an even higher price.

Another major new investor error is buying stocks that have dropped a great deal in price in the expectation that they will return to their former high value.

A stock that traded at $100 and has now crashed to $10 has likely done so for a valid reason, and may never return to its former price.

If the problems that resulted in the decline continue, it is likely the stock price will continue to go down.

The Way to Win in the Stock Market

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credit: shutterstock

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