3 Ways Investors Make Money in Stocks

[Frederick Eddy]

If you are relatively new to stock investing you may not really be
aware of all the opportunities available to you. Investors can make
money in the stock market three different ways, and can get leverage
to enhance profits as well.
The big profits in stocks are usually made through price appreciation.
In other words, you buy a stock and later sell it for a higher price
than you paid for it. Some investors hold stocks for years; some
traders might only hold a stock for a few minutes. To enhance profits,
some investors buy stocks on margin.
When you buy on margin, you borrow money from your broker who charges
you interest. What's the advantage? Let's say you have $10,000 to
invest and you really think a stock has potential for big price
increases. You buy on margin ... $20,000 worth. It doubles in price
and you sell. Instead of making $10,000 for a double, you make $20,000
with only $10,000 of your own money invested.
That's called using financial leverage (other people's money) to
increase your profits. On the flip side, losses are magnified as well,
and if your stock falls too far your broker will give you a margin
call. He will either ask you to put up more money, or he will sell out
your position. After all, they lent you $10,000 and your investment
does not look too sound at the moment.
The second way investors make money in stocks is through
dividends. Some stocks pay dividend yields of over 5%, some pay
virtually nothing in dividends. If yours pays a dividend you will be
paid (like a credit to your account) based on the number of shares you
own.
Third, you can make money by SELLING SHORT, or short selling a stock,
or by otherwise taking a SHORT position. That's how speculators get
rich when the stock market is falling. We'll keep this real simple,
because you should not do this unless you know exactly what you are
doing.
When you go SHORT, you are trying to buy low and sell high ... but in
reverse order. First you sell, and later you hope to buy at a lower
price. For example, XYZ is selling at $50 per share and you want to
bet that its price will fall. You sell it short at $50. The stock
falls to $30 and you COVER your position at that price. Your profit is
$20 per share.
When you COVERED your position in the above example, you were actually
buying shares of XYZ for $30. So, you sold upfront for $50 and later
paid $30 for a profit of $20 per share.
What really happened? Your broker borrowed shares of XYZ for you so
you could sell something you did not really own. When you later bought
your shares (covered) he returned these shares to the owner. Don't
worry about the logistics; the broker takes care of it for you.
But if you decide to sell short, you should keep a couple of things in
mind. First, you must at some point cover your position. That means
that you must someday buy shares so they can be returned. If XYZ goes
up instead of down the pressure is on you. Second, taking a short
position is like fighting the odds since most of the time stock prices
go up, not down.
In summary, there are three different ways to make money in
stocks.  You can buy low and sell high.  You can collect
dividends.  Or, you can sell high ... and later buy low (sell
short).
Even if you never do it yourself, you should understand the concept of
selling short because it is a significant and ongoing activity in the
stock market.  Short sellers often move the market, especially
when they act in unison.
I do not recommend buying stocks on margin unless you are an
aggressive investor.

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