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How to Use the Stock Market

by Carmelo J. Montalbano

Overview

Using the stock market to create wealth is mostly a matter of continuous saving and reinvesting of dividends and capital gains into the purchase of more stock. Stock markets have historically outperformed inflation, but not without risk. It is not unusual to go long periods without market gains or even market losses. Using professional guidance, technical and fundamental analysis, and constant saving will usually result in a profitable experience.

Buy Strength and Sell Weakness

Step 1

Accumulate wealth by reinvesting income from dividends. About 40 percent of the total return (the increase of wealth from both capital appreciation and dividends) is from the reinvestment of dividends. Choose companies that have regular and predictable increases in dividends over time. This implies that their profits will increase as well.
Step 2

Buy stocks only in a broad market uptrend. Technical analysis, the use of stock price and volume statistics is useful in determining whether the market is in a sustained uptrend or simply a shorter trading market. Trading stocks in bear, or downtrend, markets usually results in capital losses or less than expected returns. This is because bear markets tend to be choppy and often suddenly turn down. Avoid day trading, as commissions, fees, and the spread between the bid and asked prices consume a large amount of time and trading dollars.
Step 3

Diversify. Own many industries and market sectors. Consider exchange-traded funds so that one investment is diversified among many sectors with low management fees. Diversification maintains a more even growth rate of investing capital and thus gives investors more confidence in their investment decisions.
Step 4

Invest in what you know, or hire investment managers who understand market mechanics. Invest in companies directly using subscription services like Value Line or by using mutual funds. Buy only no-load mutual funds. Mutual funds have the advantage of cost savings, asset diversification and management expertise that the ordinary investor cannot learn independently.
Step 5

Create stop losses at the time of purchase. Stop losses represent the absolute greatest loss that an investor is willing to take on a new investment. Honor stop losses so that small mistakes do not become large mistakes.

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Always invest a portion of your income in bonds. Add to your bond position relative to your stock holdings as you approach retirement.
Always invest a portion of your income in bonds. Add to your bond position relative to your stock holdings as you approach retirement.
Stop losses should never exceed 10 percent of the value of any one investment.
Stop losses should never exceed 10 percent of the value of any one investment.