How to Buy and Sell Stocks

Stocks are a lot like sex in high school: Everyone pretends to know everything, few actually know anything, and nobody ever lets on about what they don't know. Here's what to look for, and how to build a stock portfolio that's right for you.

Difficulty:

Moderately Challenging

Instructions

Things You'll Need

• Fidelity's Comparison Table

1. Understand how stocks operate. Stocks are a form of equity investing, because when you buy shares of stock you actually get partial ownership of that company. When a company does well, its value increases, and so does the value of the shares.

2. Join the National Association of Investors Corporation (NAIC) to gain access to a low-cost stock purchase program. Members can buy stock in a long list of companies, paying as little as $10 a month, as a way to slowly build a nest egg. The cost to join NAIC is less than $50 a year and includes a monthly subscription to a magazine on investing.

3. Get to know the stock exchanges. Stocks are traded on three major exchanges in the United States: the New York Stock Exchange, which includes some of the biggest companies in the world; the American Stock Exchange; and the NASDAQ National Market System, an electronic exchange. Each exchange trades the stocks of different companies, so once you choose a company to invest in, find out which exchange it is traded on in order to monitor it.

4. Familiarize yourself with different types of stocks. Growth stocks are stocks in relatively inexpensive companies that have a good chance to increase in value. Income stocks have less growth potential but consistently produce high dividends. Other types include value stocks, which are a variant of growth stocks; cyclical stocks, which are tied to economic ups and downs; and international stocks, which are stocks in foreign companies that may or may not be traded on U.S. exchanges.

5. Clarify your investment goals. Do you need to stockpile funds for your retirement or are you looking to purchase a house within two years? Or are you looking for investments that produce income? As a general rule, the longer the investment time frame, the more aggressive you can afford to be.

6. Determine how stocks fit into your overall portfolio. Stocks, like all investments, should take up a limited portion of your assets according to your master financial plan. Construct an asset allocation for your entire investment portfolio, decide how much of it should go to stocks, and stick to that percentage. As stocks gain and lose value, you may need to buy or sell to maintain your planned mix.

7. Start with simple parameters. Pick companies that you know and products that you're familiar with. Do you use them? Are they good?

8. Understand the underlying fundamentals of the companies whose stock you buy. These include the markets they are in, their balance sheet (which shows assets and liabilities) and their competitors. Another indicator is the company's past and present earnings and how that relates to the number of shares the company has outstanding (known as earnings per share). This is a closely watched number among professional investors.

9. Review stock analyses from research firms like ValueLine and Morningstar, which sell subscriptions to their reports. Local libraries typically carry recent issues.

10. Calculate the stock's price-earnings (P/E) ratio. This ratio divides the price per share of the stock by its earnings per share. This shows you how expensive a stock price is when compared with the company's actual earnings. As a rule, the higher the P/E, the more the potential of the company may already be priced into the stock.

11. Get professional help. The most traditional avenue is through a brokerage house, where you can get firsthand advice from a broker. But you'll pay a commission for any transaction (which, depending on the house, can be substantial). See How to Choose a Stockbroker.

12. Look at online brokerages and discount houses. The commissions are low, the trades are quick, and the research resources are often extensive, but you won't get any hand-holding.

13. Match your stock to your needs and temperament: Invest in risky stocks only if you have the stomach and the time to ride out market fluctuations.

14. Diversify for greater safety. When buying several stocks, mix things up. Buy stocks from different industries, and balance aggressive stocks with more conservative choices.

Tips & Warnings

• Recent laws now reduce the tax on corporate dividends, making income stocks very attractive. Consider this new tax incentive if you are purchasing stocks for income.

• Never buy on so-called tips. Not only can the information be suspect, but tips can often circulate long after action has occurred. Trading on an old tip is like buying an umbrella after the rain has stopped.

• The dot-com era has taught investors to be cautious when following analysts' recommendations. Investment banks that publish reports on companies may also do other banking or consultation work with the company. And while this may not be a conflict of interest at every bank, it has certainly raised eyebrows in recent years. Bottom line: Overly bullish recommendations need to coincide with your own independent research.