How do you make money in the stock market?
Investing is a hobby for me. I don't know why I enjoy it so much but I do. It's cool to think that I can own a little piece of these gigantic companies like IBM and Johnson & Johnson. It's also an excellent way to grow your wealth. Historically speaking the stock market has out performed every other investment out there. Sure you might find that golden real estate investment that turns $2,000.00 into $1,000,000.00 but the chances of that happening are about like winning the lottery. Stocks offer a much more reliable return and by simply investing in an index fund you don't have to put that much effort into getting a good return (a bit more than 10% annually).
This brings us to the question though of how exactly do people make money on the stock market? Unfortunately the answer is not so simple as there are lots of ways one can try to make money. Here's a run down of the options:
1) Price appreciation
This is by far the most common and time tested way money is made with stocks. The basic premise is that over time good companies should become more valuable as they build their business and as a result the price each one of their shares will command appreciates. This may sound like a boring way to invest but it can result in some high octane, roller coaster investments, depending on which companies you choose.
Some people approach it from the standpoint of trying to find companies that have excellent future growth prospects. These companies can be really exciting to get into and can make millions for investors but there is also inherent risk betting on these companies because you are basically betting that they will appreciate in value because some product they offer will make lots of money. Some examples of these "growth" stocks that have done very well in the last 20 years include: Microsoft, Starbucks, Apple Computer, etc.
The alternative to growth investing is value investing. This style still relies on price appreciation as the method for generating profit but it tries to find companies that are trading below what the investor believes their current intrinsic value is. Of course, the investor believes this is just a temporary mispricing by the market and eventually the market will realize the mistake it has made and the price should appreciate to it's true fair market value. This style is not nearly as exciting but it can make investors a lot of money too. This was the way that the legendary investor Ben Graham taught people to invest.
Obviously there are companies that can be growth companies that are also temporarily under-valued and there any number of combinations investors can take between the two styles.
2) Profit sharing
Profit sharing is the second way investors can make money by purchasing stocks. These are sometimes referred to as dividend stocks. What happens here is that companies have decided to distribute some of their earnings to the owners of the company (shareholders) in the form of a dividend. This often happens on a quarterly or annual basis. This method of making money with stock market can produce very reliable results as the companies who typically distribute dividends are ones with solid, profitable, businesses. It's also important to note that this is not mutually exclusive to price appreciation; in fact, investors in dividend stocks also benefit from price appreciation.
3) Price depreciation (Short selling)
Price depreciation is somewhat different from the previous two methods discussed. It relies on investors finding stocks that are currently overvalued by the market. What happens is an investor finds a stock he believes is currently selling for more than the company is worth. He then agrees to sell shares of the company he does not own at the current price with a committent to actually purchase the shares he sold at a later date. If the stock has declined in price from when the investor sold the stock then he has made money, if it has appreciated then the investor has lost moeny. This is known as short selling. Of the 3 methods discussed this is by far the friskiest method of investing but that's not to say that it cannot produce good results because many people have made sizeable fortunes doing just this.
