Top things to know
1. Stocks aren't just pieces of paper.
When you buy a share of stock, you are taking a share of ownership in a company. Collectively, the company is owned by all the shareholders, and each share represents a claim on assets and earnings.
2. There are many different kinds of stocks.
The most common ways to divide the market are by company size (measured by market capitalization), sector, and types of growth patterns. Investors may talk about large-cap vs. small-cap stocks, energy vs. technology stocks, or growth vs. value stocks, for example.
3. Stock prices track earnings.
Over the short term, the behavior of the market is based on enthusiasm, fear, rumors, and news. Over the long term, though, it is mainly company earnings that determine whether a stock's price will go up, down, or sideways.
4. Stocks are your best shot for getting a return over and above the pace of inflation.
Since the end of World War II, the average large stock has returned, on average, more than 10 percent a year - well ahead of inflation, and the return of bonds, real estate and other savings vehicles. As a result, stocks are the best way to save money for long-term goals like retirement.
5. Individual stocks are not the market.
A good stock may go up even when the market is going down, while a stinker can go down even when the market is booming.
6. A great track record does not guarantee strong performance in the future.
Stock prices are based on projections of future earnings. A strong track record bodes well, but even the best companies can slip. For example, Internet router company Cisco Systems was considered a great stock to own during the technology boom of the late 1990's and early 2000; but shares lost more than 75 percent of their value over the following five years.
7. You can't tell how expensive a stock is by looking only at its price.
Because a stock's value is depends on earnings, a $100 stock can be cheap if the company's earnings prospects are high enough, while a $2 stock can be expensive if earnings potential is dim.
8. Investors compare stock prices to other factors to assess value.
To get a sense of whether a stock is over- or undervalued, investors compare its price to revenue, earnings, cash flow, and other fundamental criteria. Comparing a company's performance expectations to those of its industry is also common -- firms operating in slow-growth industries are judged differently than those whose sectors are more robust.
9. A smart portfolio positioned for long-term growth includes strong stocks from different industries.
As a general rule, it's best to hold stocks from several different industries. That way, if one area of the economy goes into the dumps, you have something to fall back on.
10. It's smarter to buy and hold good stocks than to engage in rapid-fire trading.
The cost of trading has dropped dramatically -- it's easy to find commissions for less than $10 a tra
When you buy a share of stock, you are taking a share of ownership in a company. Collectively, the company is owned by all the shareholders, and each share represents a claim on assets and earnings.
2. There are many different kinds of stocks.
The most common ways to divide the market are by company size (measured by market capitalization), sector, and types of growth patterns. Investors may talk about large-cap vs. small-cap stocks, energy vs. technology stocks, or growth vs. value stocks, for example.
3. Stock prices track earnings.
Over the short term, the behavior of the market is based on enthusiasm, fear, rumors, and news. Over the long term, though, it is mainly company earnings that determine whether a stock's price will go up, down, or sideways.
4. Stocks are your best shot for getting a return over and above the pace of inflation.
Since the end of World War II, the average large stock has returned, on average, more than 10 percent a year - well ahead of inflation, and the return of bonds, real estate and other savings vehicles. As a result, stocks are the best way to save money for long-term goals like retirement.
5. Individual stocks are not the market.
A good stock may go up even when the market is going down, while a stinker can go down even when the market is booming.
6. A great track record does not guarantee strong performance in the future.
Stock prices are based on projections of future earnings. A strong track record bodes well, but even the best companies can slip. For example, Internet router company Cisco Systems was considered a great stock to own during the technology boom of the late 1990's and early 2000; but shares lost more than 75 percent of their value over the following five years.
7. You can't tell how expensive a stock is by looking only at its price.
Because a stock's value is depends on earnings, a $100 stock can be cheap if the company's earnings prospects are high enough, while a $2 stock can be expensive if earnings potential is dim.
8. Investors compare stock prices to other factors to assess value.
To get a sense of whether a stock is over- or undervalued, investors compare its price to revenue, earnings, cash flow, and other fundamental criteria. Comparing a company's performance expectations to those of its industry is also common -- firms operating in slow-growth industries are judged differently than those whose sectors are more robust.
9. A smart portfolio positioned for long-term growth includes strong stocks from different industries.
As a general rule, it's best to hold stocks from several different industries. That way, if one area of the economy goes into the dumps, you have something to fall back on.
10. It's smarter to buy and hold good stocks than to engage in rapid-fire trading.
The cost of trading has dropped dramatically -- it's easy to find commissions for less than $10 a tra
What is a stock?
It's more than just a piece of paper (and sometimes not even that)
At some point, just about every company needs to raise money, whether to open up a West Coast sales office, build a factory, or hire a crop of engineers.
In each case, they have two choices: 1) Borrow the money, or 2) raise it from investors by selling them a stake (issuing shares of stock) in the company.
When you own a share of stock, you are a part owner in the company with a claim (however small it may be) on every asset and every penny in earnings.
Now, typical stock buyers rarely think like owners, and it's not as if they actually have a say in how things are done. Owning 100 shares of Microsoft makes you, technically speaking, Bill Gates' boss, but that doesn't mean you can call him up and give him a tongue-lashing.
Nevertheless, it's that ownership structure that gives a stock its value. If stockowners didn't have a claim on earnings, then stock certificates would be worth no more than the paper they're printed on. As a company's earnings improve, investors are willing to pay more for the stock.
Over time, stocks in general have been solid investments. That is, as the economy has grown, so too have corporate earnings, and so have stock prices.
Since 1926, the average large stock has returned more than 10 percent a year. If you're saving for retirement, that's a pretty good deal - much better than U.S. savings bonds, or stashing cash under your mattress.
Of course, "over time" is a relative term. As any stock investor knows, prolonged bear markets can decimate a portfolio.
Since World War II, Wall Street has endured a dozen bear markets - defined as a sustained decline of more than 20 percent in the value of the Dow Jones Industrial Average - including one of the sharpest and longest in history that began in March 2000.
Bull markets eventually follow these downturns, but again, the term "eventually" offers small sustenance in the midst of the downdraft.
The point to consider, then, is that investing must be considered a long-term endeavor if it is to be successful. In order to endure the pain of a bear market, you need to have a stake in the game when the tables turn positive.
In each case, they have two choices: 1) Borrow the money, or 2) raise it from investors by selling them a stake (issuing shares of stock) in the company.
When you own a share of stock, you are a part owner in the company with a claim (however small it may be) on every asset and every penny in earnings.
Now, typical stock buyers rarely think like owners, and it's not as if they actually have a say in how things are done. Owning 100 shares of Microsoft makes you, technically speaking, Bill Gates' boss, but that doesn't mean you can call him up and give him a tongue-lashing.
Nevertheless, it's that ownership structure that gives a stock its value. If stockowners didn't have a claim on earnings, then stock certificates would be worth no more than the paper they're printed on. As a company's earnings improve, investors are willing to pay more for the stock.
Over time, stocks in general have been solid investments. That is, as the economy has grown, so too have corporate earnings, and so have stock prices.
Since 1926, the average large stock has returned more than 10 percent a year. If you're saving for retirement, that's a pretty good deal - much better than U.S. savings bonds, or stashing cash under your mattress.
Of course, "over time" is a relative term. As any stock investor knows, prolonged bear markets can decimate a portfolio.
Since World War II, Wall Street has endured a dozen bear markets - defined as a sustained decline of more than 20 percent in the value of the Dow Jones Industrial Average - including one of the sharpest and longest in history that began in March 2000.
Bull markets eventually follow these downturns, but again, the term "eventually" offers small sustenance in the midst of the downdraft.
The point to consider, then, is that investing must be considered a long-term endeavor if it is to be successful. In order to endure the pain of a bear market, you need to have a stake in the game when the tables turn positive.
Different kinds of stocks
Not sure what a small cap is or why you should care? Read on.
There are thousands of stocks to choose from, so investors usually like to put stocks into different categories: size, style, and sector.
By size
A company's size refers to its market capitalization, which is the current share price times the total number of shares outstanding. It's how much investors think the whole company is worth.
Ford, for example, has 2.11 billion shares outstanding, and in December 2007 each share was trading for $6.90. So the company's total market capitalization is about $14.5 billion. (Technically, if you had an extra $14.5 billion lying around, you could buy each share of stock, and own the whole company.)
Is $14 billion a lot or a little? No official rules govern these distinctions, but below are some useful guidelines for assessing size.
Large-cap companies tend to be established and stable, but because of their size, they have lower growth potential than small caps.
General Electric, one of the most highly valued companies in the world with a market cap of more than $380 billion, has posted steady long-term returns, but don't expect it to double anytime soon.
Over the long run, small-cap stocks have tended to rise at a faster pace. It's much easier to expand revenues and earnings quickly when you start at, say, $10 million than $10 billion. When profitability rises, stock prices follow.
There is a trade-off, though. With less developed management structures, small caps are more likely to run into troubles as they grow - expanding into new areas and beefing up staff are examples of potential pitfalls. (Of course, even corporate titans get into trouble. Witness the collapse of General Motors' stock in 2005, when the share price fell from about $40 to about $20.)
By style
A "growth" company is one that is expanding at an above-average rate. Cisco, for instance, increased its earnings nearly 40 percent a year in the late 1990's - the average tends to run around 10 percent.
Catch a successful growth stock early on, and the ride can be spectacular. But again, the greater the potential, the bigger the risk. Growth stocks race higher when times are good, but as soon as growth slows those stocks tank.
If you'd picked up 100 shares of Cisco in 1995, your stake would have cost you a little more than $3,000. By early 2001, that investment grew to $68,400.
Cisco fell from grace, however. If you were unlucky enough to have purchased Cisco shares at their absolute peak price, you would have lost nearly 90 percent of your money by September 2002, when the stock was trading below $9.
The opposite of growth is "value." There is no one definition of a value stock, but in general, it trades at a lower than average earnings multiple than the overall market. Maybe the company has messed up, causing the stock to plummet - a value investor might think the underlying business is still sound and its true worth not reflected in the depressed stock price.
A "cyclical" company makes something that isn't in constant demand throughout the business cycle. For example, steel makers see sales rise when the economy heats up, spurring builders to put up new skyscrapers and consumers to buy new cars.
But when the economy slows, their sales lag too. U.S. Steel, the largest steel maker, lost money during the recession of 2001. Cyclical stocks bounce around a lot as investors try to guess when the next upturn and downturn will come.
By sector
Standard & Poor's breaks stocks into 10 sectors and dozens of industries. Generally speaking, different sectors are affected by different things. So at any given time, some are doing well while others are not.
In most cases, finance, health care, and technology tend to be the fastest growing sectors, while consumer staples and utilities offer stability with moderate growth. The other sectors tend to be cyclical, expanding quickly in good times and contracting during recessions.
By size
A company's size refers to its market capitalization, which is the current share price times the total number of shares outstanding. It's how much investors think the whole company is worth.
Ford, for example, has 2.11 billion shares outstanding, and in December 2007 each share was trading for $6.90. So the company's total market capitalization is about $14.5 billion. (Technically, if you had an extra $14.5 billion lying around, you could buy each share of stock, and own the whole company.)
Is $14 billion a lot or a little? No official rules govern these distinctions, but below are some useful guidelines for assessing size.
Large-cap companies tend to be established and stable, but because of their size, they have lower growth potential than small caps.
General Electric, one of the most highly valued companies in the world with a market cap of more than $380 billion, has posted steady long-term returns, but don't expect it to double anytime soon.
Over the long run, small-cap stocks have tended to rise at a faster pace. It's much easier to expand revenues and earnings quickly when you start at, say, $10 million than $10 billion. When profitability rises, stock prices follow.
There is a trade-off, though. With less developed management structures, small caps are more likely to run into troubles as they grow - expanding into new areas and beefing up staff are examples of potential pitfalls. (Of course, even corporate titans get into trouble. Witness the collapse of General Motors' stock in 2005, when the share price fell from about $40 to about $20.)
By style
A "growth" company is one that is expanding at an above-average rate. Cisco, for instance, increased its earnings nearly 40 percent a year in the late 1990's - the average tends to run around 10 percent.
Catch a successful growth stock early on, and the ride can be spectacular. But again, the greater the potential, the bigger the risk. Growth stocks race higher when times are good, but as soon as growth slows those stocks tank.
If you'd picked up 100 shares of Cisco in 1995, your stake would have cost you a little more than $3,000. By early 2001, that investment grew to $68,400.
Cisco fell from grace, however. If you were unlucky enough to have purchased Cisco shares at their absolute peak price, you would have lost nearly 90 percent of your money by September 2002, when the stock was trading below $9.
The opposite of growth is "value." There is no one definition of a value stock, but in general, it trades at a lower than average earnings multiple than the overall market. Maybe the company has messed up, causing the stock to plummet - a value investor might think the underlying business is still sound and its true worth not reflected in the depressed stock price.
A "cyclical" company makes something that isn't in constant demand throughout the business cycle. For example, steel makers see sales rise when the economy heats up, spurring builders to put up new skyscrapers and consumers to buy new cars.
But when the economy slows, their sales lag too. U.S. Steel, the largest steel maker, lost money during the recession of 2001. Cyclical stocks bounce around a lot as investors try to guess when the next upturn and downturn will come.
By sector
Standard & Poor's breaks stocks into 10 sectors and dozens of industries. Generally speaking, different sectors are affected by different things. So at any given time, some are doing well while others are not.
In most cases, finance, health care, and technology tend to be the fastest growing sectors, while consumer staples and utilities offer stability with moderate growth. The other sectors tend to be cyclical, expanding quickly in good times and contracting during recessions.
How much should you pay?
The right way to use P/E and other valuation tools
When times are good, investors think the happy days will last forever, and they are willing to pay exorbitant amounts for earnings.
When times are bad, they assume the world is ending and refuse to pay much of anything. In assessing how much a stock is worth, investors talk about "valuation," the stock price relative to any number of criteria.
Price/earnings (P/E) ratio
Everybody uses it, but not everybody understands it. The actual P/E calculation is easy: Just divide the current price per share by earnings per share.
But what number should you use for earnings per share? The sum of the past four quarters? Estimates for next year?
There is no right answer. The P/E based on the past four quarters provides the most accurate reflection of the current valuation, because those earnings have already been booked.
But investors are always looking ahead, so most also pay attention to estimates, which also are widely available at financial Websites (including CNNMoney.com).
Wall Street analysts generally compute earnings per share estimates for the current fiscal year and the next fiscal year and use those estimates to assign a P/E, though there is no guarantee that the company will meet those estimates.
The P/E can't tell you whether to buy or sell. It is merely a gauge to tell you whether a stock is overvalued or undervalued. Assuming they have the same total shares outstanding, is a $100 stock more expensive than a $50 stock?
Not exactly. Where valuation is concerned, price is dictated by expectations of future performance. If the earnings of the higher-priced company are growing considerably faster than the other, the higher price may be justified.
What's an appropriate P/E? Different types of stocks win different valuations. Generally, the market pays up for growth or enormous profitability. Consider GE and Microsoft, two well-run companies that vie for the title of biggest market capitalization. GE takes in more revenue in a quarter than Microsoft does in a year. Yet Microsoft boasts enormously fat profit margins and generally stronger growth prospects than GE does in many of its businesses.
That's why the market rewards Microsoft with a higher P/E than GE, despite the relative size of their respective businesses. At year-ed 2007, the market valued Microsoft's earnings at 23 times, and GE's earnings at 17 times.
To quickly compare P/Es and growth rates, use the PEG ratio - the P/E (based on estimates for the current year) divided by the long-term growth rate. A company with a P/E of 36 and a growth rate of 20 percent has a PEG of 1.8.
In general, you want a stock with a PEG that's close to 1.0 (or lower), which means it is trading in line with its growth rate. But for a quality company, you can pay more.
Also, don't get excited by rock-bottom P/Es - some companies are doomed to low valuations. One group the market tends to penalize is cyclicals, companies whose performance rises and falls with the economy.
When times are good, General Motors, for example, can be highly profitable. But because automakers tend to be hit hard during general economic downturns, investors account for the next recession in GM shares by awarding them a lower P/E.
Price/Sales ratio
Just as investors like to know how much they're paying for earnings, it's also useful to know how much they're paying for revenue (the terms "sales" and "revenue" are used interchangeably).
To calculate the Price/Sales ratio, divide the stock price by the total sales per share for the past 12 months. You could also use revenue estimates for the next fiscal year, which are being published more frequently on financial websites.
Like P/Es, Price/Sales ratios are all over the map, with fast-growers tending to get the highest valuations.
Price/Book Value ratio
Defined simply, book value equals a company's total assets minus its total liabilities and intangible assets. In other words, if you liquidated a firm, this is what the leftover assets would be worth after paying off all your creditors.
On the balance sheet, book value is represented as "shareholders' equity." (Dividing this aggregate total by the number of shares outstanding will give you a per-share book value.)
This is a more conservative measure, which embraces a "bird-in-hand" philosophy of valuation. Investors use it to spot cases in which the market is over- or undervaluing a company's true strength.
For example, a retailer that owns the buildings its stores are housed in might be sitting on unrealized real estate gains.
When times are bad, they assume the world is ending and refuse to pay much of anything. In assessing how much a stock is worth, investors talk about "valuation," the stock price relative to any number of criteria.
Price/earnings (P/E) ratio
Everybody uses it, but not everybody understands it. The actual P/E calculation is easy: Just divide the current price per share by earnings per share.
But what number should you use for earnings per share? The sum of the past four quarters? Estimates for next year?
There is no right answer. The P/E based on the past four quarters provides the most accurate reflection of the current valuation, because those earnings have already been booked.
But investors are always looking ahead, so most also pay attention to estimates, which also are widely available at financial Websites (including CNNMoney.com).
Wall Street analysts generally compute earnings per share estimates for the current fiscal year and the next fiscal year and use those estimates to assign a P/E, though there is no guarantee that the company will meet those estimates.
The P/E can't tell you whether to buy or sell. It is merely a gauge to tell you whether a stock is overvalued or undervalued. Assuming they have the same total shares outstanding, is a $100 stock more expensive than a $50 stock?
Not exactly. Where valuation is concerned, price is dictated by expectations of future performance. If the earnings of the higher-priced company are growing considerably faster than the other, the higher price may be justified.
What's an appropriate P/E? Different types of stocks win different valuations. Generally, the market pays up for growth or enormous profitability. Consider GE and Microsoft, two well-run companies that vie for the title of biggest market capitalization. GE takes in more revenue in a quarter than Microsoft does in a year. Yet Microsoft boasts enormously fat profit margins and generally stronger growth prospects than GE does in many of its businesses.
That's why the market rewards Microsoft with a higher P/E than GE, despite the relative size of their respective businesses. At year-ed 2007, the market valued Microsoft's earnings at 23 times, and GE's earnings at 17 times.
To quickly compare P/Es and growth rates, use the PEG ratio - the P/E (based on estimates for the current year) divided by the long-term growth rate. A company with a P/E of 36 and a growth rate of 20 percent has a PEG of 1.8.
In general, you want a stock with a PEG that's close to 1.0 (or lower), which means it is trading in line with its growth rate. But for a quality company, you can pay more.
Also, don't get excited by rock-bottom P/Es - some companies are doomed to low valuations. One group the market tends to penalize is cyclicals, companies whose performance rises and falls with the economy.
When times are good, General Motors, for example, can be highly profitable. But because automakers tend to be hit hard during general economic downturns, investors account for the next recession in GM shares by awarding them a lower P/E.
Price/Sales ratio
Just as investors like to know how much they're paying for earnings, it's also useful to know how much they're paying for revenue (the terms "sales" and "revenue" are used interchangeably).
To calculate the Price/Sales ratio, divide the stock price by the total sales per share for the past 12 months. You could also use revenue estimates for the next fiscal year, which are being published more frequently on financial websites.
Like P/Es, Price/Sales ratios are all over the map, with fast-growers tending to get the highest valuations.
Price/Book Value ratio
Defined simply, book value equals a company's total assets minus its total liabilities and intangible assets. In other words, if you liquidated a firm, this is what the leftover assets would be worth after paying off all your creditors.
On the balance sheet, book value is represented as "shareholders' equity." (Dividing this aggregate total by the number of shares outstanding will give you a per-share book value.)
This is a more conservative measure, which embraces a "bird-in-hand" philosophy of valuation. Investors use it to spot cases in which the market is over- or undervaluing a company's true strength.
For example, a retailer that owns the buildings its stores are housed in might be sitting on unrealized real estate gains.
Picking stocks for your portfolio
Adapted from Michael Sivy's "Sivy on Stocks" column, "Low-risk growth investing."
Although there are more than 6,000 publicly traded companies, the core of your stock portfolio should consist of financially strong companies with above-average earnings growth.
Surprisingly, there are only about 200 stocks that fit that description. A well-balanced stock portfolio should consist of 15 to 20 stocks, across seven or more different industries - but you don't have to buy them all at once.
Since you want to be able to hold your stocks for a long time, they should offer a total return higher than the 10 percent historical market average. You can estimate the likely return by adding the dividend yield to the projected earnings growth rate - a stock with 11 percent earnings growth and a 2 percent yield could provide a 13 percent annual total return.
As a general rule, stocks with moderately above-average growth rates and reasonable valuations are the best buys. Statistically, high-growth stocks are usually overpriced and have a harder time meeting inflated investor expectations.
The first thing to look at is the stock's price/earnings ratio compared with its projected total return. Ideally, the P/E should be less than double the projected return (a P/E of no more than 30 for a stock with 15 percent total return potential).
A well-balanced portfolio might include a couple of industrials with 9 percent growth rates and 3 percent yields, selling at 17 P/Es, as well as consumer growth stocks with 13 percent growth rates and 1 percent yields, at 23 P/Es. Add a couple of tech stocks with 25 percent growth rates and high P/Es (don't overdo it on those).
If you can average a 14 percent return over the next 10 to 20 years, you'll reach your financial goals - and probably outperform most pros as well.
Although there are more than 6,000 publicly traded companies, the core of your stock portfolio should consist of financially strong companies with above-average earnings growth.
Surprisingly, there are only about 200 stocks that fit that description. A well-balanced stock portfolio should consist of 15 to 20 stocks, across seven or more different industries - but you don't have to buy them all at once.
Since you want to be able to hold your stocks for a long time, they should offer a total return higher than the 10 percent historical market average. You can estimate the likely return by adding the dividend yield to the projected earnings growth rate - a stock with 11 percent earnings growth and a 2 percent yield could provide a 13 percent annual total return.
As a general rule, stocks with moderately above-average growth rates and reasonable valuations are the best buys. Statistically, high-growth stocks are usually overpriced and have a harder time meeting inflated investor expectations.
The first thing to look at is the stock's price/earnings ratio compared with its projected total return. Ideally, the P/E should be less than double the projected return (a P/E of no more than 30 for a stock with 15 percent total return potential).
A well-balanced portfolio might include a couple of industrials with 9 percent growth rates and 3 percent yields, selling at 17 P/Es, as well as consumer growth stocks with 13 percent growth rates and 1 percent yields, at 23 P/Es. Add a couple of tech stocks with 25 percent growth rates and high P/Es (don't overdo it on those).
If you can average a 14 percent return over the next 10 to 20 years, you'll reach your financial goals - and probably outperform most pros as well.
How to buy stocks
From Talking Money, (Warner Books 2001) by MONEY editor-at-large Jean Chatzky
When you're looking for a broker, you have three distinct choices. From the most to the least expensive, they are: full-service brokers, discount brokers, and online brokers. What differentiates them is the advice they provide and cost.
Full-service brokers will call with stock ideas and back this advice with reports from their firm's research department. They'll keep an eye on your picks and let you know when they think changes are necessary.
Discounters do less of this. While there's typically plenty of research available on the best online brokerage sites, it's up to you to dig for it.
You may want to choose different kinds of brokers for different purposes. I believe that full-service brokers should get paid for their stock ideas. That seems only fair. But if you've done your research yourself, I don't see any reason to pay a hefty commission - discounters probably are fine.
The nice thing about the way the brokerage world is shaping up is that you may be able to have both of those things in one account at one firm.
Merrill Lynch and most other full-service brokers have come around to the fact that they need an online component - and need to charge you lower commissions when you use it. Discounters like Schwab and Fidelity have both started offering a fuller range of services in recent years, while retaining their low-cost structure.
If you decide to sign on with a full-service broker, you should make sure that person has nothing to hide. To get a report on any broker, call the National Association of Securities Dealers at 800-289-9999, or visit the broker's Website.
Full-service brokers
Cost: Commissions are typically based on a percentage of your purchase (or sale) price.
Notable names to choose from include money-center titans like Merrill Lynch, Morgan Stanley, and Citigroup's Smith Barney, as well as smaller firms like Edward Jones and Raymond James.
Discount brokers
Cost: Schwab charges $12.95 for a trade of 1,000 shares or less, and on average, discounters charge one-third the price of full-service brokers.
Notable names to choose from include Charles Schwab, TD Ameritrade, and Fidelity.
Online brokers
Cost: At $9 to $15 a trade, it doesn't get any cheaper than this.
Names to choose from include Schwab, TD Ameritrade and Fidelity.
When trying to place a buy or sell order, you'll be faced with all sorts of questions: Market or limit order? "Day only" or "Good 'till cancelled." Here's the vocabulary you need to know to place a trade.
If you place a market order with your broker, then you are saying that you're willing to buy at whatever happens to be the prevailing price for the stock. If you have a specific price in mind, you can set a limit order specifying the price you're willing to pay. If the stock dips down to that level, your order will be automatically filled. Limit orders can be left open for a single day (a day order) or indefinitely (good until canceled).
After you've bought a stock, you can instruct your broker to sell it if the price drops to a level you specify (a stop loss order). That's a kind of insurance; it means that no matter what happens to a stock's price you'll never lose more than a specified amount.
In a volatile market, however, setting a stop-loss order at 10 or 20 percent below the purchase price will sometimes cause you to cash out of the stock on a momentary dip - thus locking in a loss even though the shares may immediately head back upward.
When you're looking for a broker, you have three distinct choices. From the most to the least expensive, they are: full-service brokers, discount brokers, and online brokers. What differentiates them is the advice they provide and cost.
Full-service brokers will call with stock ideas and back this advice with reports from their firm's research department. They'll keep an eye on your picks and let you know when they think changes are necessary.
Discounters do less of this. While there's typically plenty of research available on the best online brokerage sites, it's up to you to dig for it.
You may want to choose different kinds of brokers for different purposes. I believe that full-service brokers should get paid for their stock ideas. That seems only fair. But if you've done your research yourself, I don't see any reason to pay a hefty commission - discounters probably are fine.
The nice thing about the way the brokerage world is shaping up is that you may be able to have both of those things in one account at one firm.
Merrill Lynch and most other full-service brokers have come around to the fact that they need an online component - and need to charge you lower commissions when you use it. Discounters like Schwab and Fidelity have both started offering a fuller range of services in recent years, while retaining their low-cost structure.
If you decide to sign on with a full-service broker, you should make sure that person has nothing to hide. To get a report on any broker, call the National Association of Securities Dealers at 800-289-9999, or visit the broker's Website.
Full-service brokers
Cost: Commissions are typically based on a percentage of your purchase (or sale) price.
Notable names to choose from include money-center titans like Merrill Lynch, Morgan Stanley, and Citigroup's Smith Barney, as well as smaller firms like Edward Jones and Raymond James.
Discount brokers
Cost: Schwab charges $12.95 for a trade of 1,000 shares or less, and on average, discounters charge one-third the price of full-service brokers.
Notable names to choose from include Charles Schwab, TD Ameritrade, and Fidelity.
Online brokers
Cost: At $9 to $15 a trade, it doesn't get any cheaper than this.
Names to choose from include Schwab, TD Ameritrade and Fidelity.
When trying to place a buy or sell order, you'll be faced with all sorts of questions: Market or limit order? "Day only" or "Good 'till cancelled." Here's the vocabulary you need to know to place a trade.
If you place a market order with your broker, then you are saying that you're willing to buy at whatever happens to be the prevailing price for the stock. If you have a specific price in mind, you can set a limit order specifying the price you're willing to pay. If the stock dips down to that level, your order will be automatically filled. Limit orders can be left open for a single day (a day order) or indefinitely (good until canceled).
After you've bought a stock, you can instruct your broker to sell it if the price drops to a level you specify (a stop loss order). That's a kind of insurance; it means that no matter what happens to a stock's price you'll never lose more than a specified amount.
In a volatile market, however, setting a stop-loss order at 10 or 20 percent below the purchase price will sometimes cause you to cash out of the stock on a momentary dip - thus locking in a loss even though the shares may immediately head back upward.
