Stock Investing - How the Stock Market Works

By Louis Navellier

Stock investing isn't easy, and it can certainly be stressful. But don't think it's off-limits to average people-I've helped thousands of folks reach their financial dreams just by providing a little bit of insight into Wall Street. To help you get started on the way to financial freedom, I'd like to provide a general framework to outline how the stock market works and how to wisely invest your money.
Investing 101: Economics comes in two parts-microeconomics and macroeconomics. The "micro" view deals with the actions of businesses and consumers like you and me, while the "macro" view deals with numbers on a much larger scale-like GDP, inflation, unemployment and international trade. This might sound a bit complicated, because ultimately there is one economy. But the economic activity of everyday folks often is influenced by changes in the big picture. Similarly, the action of thousands of individual consumers can dramatically shift the broader statistics.
How the Stock Market Works
The stock market is little more than a representation of economic trends, both small and large. The market is a crucial components of the economy because it gives companies access to capital, and investors a chance to profit through ownership in that firm. Collectively, investors are very smart. That means the best companies will generally find willing buyers, driving the price up, and the worst will be left all alone, and the price will suffer. Think of it as simple "supply and demand" as it relates to your stake in a company. If a company has a good idea that is bound to make a lot of money, more people will want to get in on the action and will be willing to pay more to be a part of it. If a company fails to react to the economic trends and is doomed for failure, fewer people are willing to pay for a stake in its future.
The stock market is comprised of a) the primary market, where the initial public offering of securities originates; and b) the secondary market, where trading takes place.
Generally, the stock market affects business investment in three direct ways:
The market traditionally serves as a gauge of the expectations of the business-minded community. When the market is upbeat and the volume of transactions is high, this indicates a generally favorable business climate. This climate signals to companies that's there's plenty of capital available to pursue expansion plans. On the flipside, when the market is lethargic, executives frequently recoil and put expansion plans on hold because there's not enough money out there.
The second effect has to do with the relative ease of issuing new securities. When businesses are looking to finance investments, they issue new stocks and bonds. The proceeds are then put towards purchasing plants and equipment to further facilitate a business expansion. When a market is buoyant, it's easier for companies to issue new securities and raise funds.
The third effect pertains to weak markets. When the market is sluggish, companies with healthy earnings will try to acquire other companies or buy up shares of their own stock instead of using those earnings to fund investment. This facilitates the overall growth of a fundamentally sound company, but has little growth impact on the overall economy.
Four Tips for Successful Stock Investing
In a nutshell, "investing" means the use of money in hope of making more money. But sometimes it's easier said than done. The best way to make money is to arm yourself with the necessary knowledge to plan your stock investing strategy.
First, ask yourself which method you prefer: fundamental analysis-measuring a company's intrinsic value-or technical analysis-studying charts and patterns to analyze market activity? Personally, I'm strongly in favor of picking stocks based on the ability to increase sales, widen profit margins and report strong earnings.
Objectivity and discipline are necessary when stock investing. Remove as much of the emotion out of your strategy as possible. You'd be surprised how many investors fall in love with their stocks. Be sure to exercise discipline when executing your stock investing strategy. If you're not willing to stick to it, the more you open yourself up to making mistakes.
Portfolio diversification is an absolute must when stock investing. Your strategy is only as effective as the strength of your portfolio. The more stocks you own from different sectors, and the more equally you weight them, the easier it is to reduce risk and maximize your chance for financial success. My general rule of thumb is to have 60% of your portfolio in conservative stocks with little volatility, 30% in moderately aggressive stocks, and 10% in the aggressive stocks that can really jump around. This helps reduce risk, and generate more even returns.
Remember: Growth is the fundamental characteristic you should be looking for when deciding where to invest. Businesses are constantly seeking new ways to maximize profits, and in order to do this they must expand. To expand, however, they need a healthy balance sheet with positive cash flow. Be sure to invest in companies with solid intrinsic value but also tremendous growth potential.
Understanding how the stock market works is crucial to developing an effective stock investing strategy. You don't need to be an expert to devise a strategy that's right for you, but sticking to a few Investing 101 tips can go a long way.
Louis Navellier has earned a national reputation as a savvy stock picker and portfolio manager over the past 27 years. He writes four newsletters/trading services for individual investors, Emerging Growth, Blue Chip Growth, Quantum Growth and Global Growth. He informs readers where to invest, and delivers the latest in stock advice.
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