How Do You Make Money Through the Stock Market?

How Do You Make Money Through the Stock Market?

Nearly all people interested in trading understand that making money through the stock market is about buying a stock at a low price and selling at a higher one (a.k.a capital appreciation).

But when they first start learning about how the stock market works, most people don’t realize that they can profit without counting on capital appreciation.

There are, actually, 4 main ways that stock traders use to make money. Interestingly enough, 2 of them don’t even involve owning stocks.

In this guide, we are going to take a look at all of these ways so you’ll know exactly how the stock market works and how you can make money.

Let’s take a look!

Capital Appreciation

Capital appreciation is the rise of an asset’s price. It occurs when you buy an asset like stock and its price increases while you own it. You can profit by selling it at a higher price.

Intuitive as it sounds, most traders fail to buy low and sell high. The majority actually buys high and sells low, in retrospect. That’s because of a universal inability to predict the direction of market prices.

That inability doesn’t have to be yours, however. There are many ways to predict stock prices and the most famous of those are technical analysis and fundamental analysis).

You can either equip yourself with the knowledge you need to profit from capital appreciation or choose someone to do it for you.

Passive Income

There are two common ways to create a passive income stream through stock market investing: dividend and preferred stocks.

Let’s examine both of them, one by one.

Dividend Stocks

A dividend stock is one that is issued by a corporation that distributes a portion of its earnings (dividend) to shareholders. Most companies that pay dividends do so on a quarterly basis.

Dividends are mostly for retirees or people who would like to be paid cash often while they see their funds appreciate in value.

There are also those who want to start investing in real estate but have insufficient funds/credit to do so.

For those, REITs (Real Estate Investment Trusts) present a great alternative. They are simply companies that invest in income-producing real estate and distribute at least 90% of their income as a dividend to shareholders.

Just bear in mind that dividend stocks may stop paying dividends at any time. To manage that risk, you should try to look for those companies that have been paying dividends for years, have been increasing the amount over time, and never cut their dividends. These are often called dividend aristocrats.

If you can’t or just don’t want to handle investing in dividend stocks by yourself, you can select ETFs that do that for you.

Preferred Stocks

A preferred stock is a hybrid asset that has attributes of both equity and debt.

Preferred stocks give the owner a stake in the business as common stocks do. At the same time, they also pay their owner interest and can be purchased back from them if the company wants to do so like bonds.

They are also different from common stocks in that they are entitled to dividends before common stock shareholders can receive anything. And the interest paid on them is usually higher than what bonds offer.

Preferred stocks are for those looking for passive income but don’t want the volatility that common stocks are associated with, nor the lower interest that bonds are known to pay.

But there are risks! In the worst-case scenario that a company must file for bankruptcy, preferred shares are lower in line than creditors when it comes to getting paid. The company that issues them can also stop paying interest on them for some time, unlike the case with bonds (though it will have to pay all of the missed payments in the end).

Another less serious risk is that the company may redeem (buy back) preferred shares, leaving the investor with the need to find another issued preferred stock to allocate their money. However, you can remove that risk by investing in non-redeemable preferred shares that the issuer can’t repurchase.

If you’re not excited about the prospect of investing in preferred stocks on your own, consider an ETF that is designed to do exactly that.

Short Selling

Short selling is a process that investors use to try and profit from a falling stock price.

It involves borrowing shares from your broker and immediately selling them in the market with the intention to buy them back at a lower price, give them back to your broker, and keep the difference.

The advantage of short selling is that it gives investors the ability to bet against stocks and access more trading opportunities.

The disadvantage is that your potential gains are limited, and your potential losses are theoretically infinite. A stock’s price can only go to zero while falling, but it can theoretically rise forever.

For this reason, it’s best not to allocate too much of your portfolio towards selling short. And it’s ideal that you thoroughly educate yourself on this strategy first.

Options Trading

When it comes to the stock market, an options contract is an agreement between two parties to buy/sell shares at a specified price. These parties consist of the “underwriter” and the “buyer.”

The underwriter is the one who writes the options contract, and the buyer is the one who buys it. The price of the contract is called “premium.”

When you buy an options contract from an underwriter, you receive the right (but not the obligation) to buy or sell 100 shares of a stock at a predetermined price called the “strike price.” And when you buy or sell the underlying stock of an options contract at the strike price, you “exercise” that contract.

There are two types of options: call and put options (or calls and puts). Buying a call option gives you the right to buy a stock at the strike price and a put option gives you the right to sell it at the strike price.

You would buy a call option if you thought that the price would rise above the strike price, allowing you to buy at the strike and sell at the market price. Likewise, you would choose a put option if you thought that the stock’s price is going to trade lower than the strike price, so you could buy at the market price (lower) and sell at the strike price (higher).

Now, options contracts have expiration dates; you have a limited time frame to exercise your options and buy/sell the underlying stocks.

If you don’t exercise your contract because the stock price isn’t going the way you want or for any other reason, they expire worthless. In this scenario, the underwriter gets to keep the premium, and you end up with nothing.

If things go your way and you decide to exercise the contract, the underwriter will have to buy from or sell you the underlying stock at the strike price.

But you don’t have to exercise options if you don’t want to. If things are going your way and there’s demand for that particular contract you hold, you can always sell it at a profit.

Generally, trading stock options is more lucrative than exercising them. But they are also very risky securities as they expire worthless if you cannot find a buyer. On top of that, they lose much of their value the closer they are to expiration.

You stand to lose most or even all of your money when trading them, so educating yourself first is recommended.

Next Steps

Since you now know all of the main ways traders make money in the stock market, you’re ready to choose what approach is best for you.

Most of the approaches above can also be implemented through investing in an ETF or mutual fund. So you also need to choose between learning how to implement them yourself or entrusting someone else to do it for you.

Whatever you choose to do, you will need a broker to trade. That’s why we created a free tool that helps you select the right one for you based on criteria like the trading currency, deposit method preferences, trading style, preferred securities, etc.