Getting Started

The Stock Market: A Beginners Guide

Here we take a beginners look at what the Stock Market is and how it works.

Introduction
Apart from the glitz and panache of Hollywood or the iconic World of the pop star the stock market is probably seen as the most glamorous way of making a living (and a very healthy living at that!). Over recent times advances in technology have made the Stock Market far more accessible to the general public. This has made the possibility of becoming rich from stocks far more realistic than obtaining a record deal or a landing a role in a Hollywood production.

Unfortunately involvement in the Stock Market is not a one-way street. It is commonly acknowledged that losing a fortune in Stocks is much easier than gaining one. You will constantly see figures touted for the percentage of people who lose money trading or investing. They range from 90% to as much as 99% depending on which ?market guru? is selling you their foolproof guide to making money.

The true pros, however, will tell you the key to being a successful Stock speculator is being able to make decisions for yourself based on your own set of rules. Just like a baby learns to crawl before learning to walk and run, you must begin by learning the stock market basics.

Ignoring the Hearsay
The chances are that all you hear concerning the Stock Market comes from either a work colleague or the ten-second report delivered on your evening news. This news report is as interesting as it is useful, not at all. On the other hand what you hear at work should be ignored for other reasons. If you are a complete stock novice, no offence intended, this hearsay might sound very interesting and possibly even tempting. The typical conversation will go something like this:

Colleague: ?Did you hear about Mike from payrolls??
You: ?No, what about him??
Colleague: ?He made a few grand from Stock ?WXYZ? last month.?
You: ?Wow, I could really do with that money right now.?
Colleague: ?Me too. He says he has a few more hot tips for us if we are interested.?

Well done to Mike, but the chances are the next conversation you have with this colleague will go something like this:

Colleague: ?Have you seen Mike from payrolls??
You: ?No, why??
Colleague: ?I lost my shirt on that ?hot tip? he gave me. I want to give him a piece of my mind.?

Although this conversation is complete fiction it is not at all unrealistic. It serves as a classic example as to why you should learn to make you own investment decisions, and pay no attention to what your friend at work or drinking buddies down at the pub think.

Shares, Stock and Equity
When the media, your broker or your mates talk about The Market you will hear them use the terms Stock, Share and Equity. Slightly confusing, you might think, but the reality is they all mean the same thing. Examples of how the terms are used can be seen below:

Stock ? ?I?m a big time player in the Stock Market.?
Share (s) ? ?Sara just bought 2 000 shares in company ?XYZ?.?
Equity ? ?Now over to our financial correspondent and a look at today?s Equity Market.?

All of these terms mean the same thing, partial ownership of a company, and all three are interchangeable in any of the above examples. The more Shares you acquire the greater your stake in the company becomes.

As a shareholder you will have a claim to a portion of the company?s earnings, paid in dividends, and any voting rights attached to the share. It is standard practice to have one vote per common share to be used when electing the Board of Directors. It is the Board?s responsibility to increase the value of the company (your share) for you so it is only right that you get a say in who gets appointed.

Just because you are a partial owner it does not mean that you will be in any way responsible for the running of the company, nor does it afford you a discount on any of their products or services!

It used to be the case that shareholders were presented with a certificate to prove their ownership. If you had wanted to sell your shares you would have had to take the actual certificates the exchange. However, with the birth and evolution of the computer and electronic trading this is no longer necessary. You can now buy and sell your shares with the click of a mouse or a phone call and you are no longer issued with a certificate. To ease the flow of transfer, certificates are now held in electronic form by your broker (in street name). This makes it possible to transfer ownership (buy and sell) in a fraction of a second. In fact day traders do just that, many times every day.

Why Issue Stock?
So why do companies issue stock in the first place? Lets face it; it means they share their ownership and their profits with the general public for the price of a share. The reason is to raise money. By selling off a slice of their business they can raise hundreds of millions of dollars without having to pay any of it back or pay any interest on it. This method of raising funds is knows as equity financing.

The alternative to equity financing is debt financing. This is where a company issues bonds or takes out a bank loan.

What Happens if the Company Goes Bust? If the company you have invested in goes bust then you are only liable for the amount you have invested in that company, i.e. the number of shares you own multiplied by the initial cost of each share. This does not mean that creditors will come after you for that amount it simply means your shares will be worth nothing. Only once the creditors have sold off the company?s assets to cover its debts the shareholders have a claim on any assets remaining. This is known as absolute priority.

Stocks Vs Bonds As we know bonds are a form of debt financing. To invest in bonds does have some advantages over buying shares. For example, you will receive a guaranteed interest payment throughout the life of the bond (some companies don?t pay dividends) and you are guaranteed the return of your initial investment known as the principal. We already know that this is not the case as a stock?s price can just as easily fall from the value at which you made your investment. However, with greater risk comes greater reward; traditionally stocks have outperformed bonds on rate of return.

Preferred Stock So far the shares/ stock we have referred to is known as common stock. As the name suggests this is the most widely traded type of share. However, there is another type of stock, preferred stock. This is a cross between common stocks and bonds. Preferred stockholders are repaid before common stockholders (but still after creditors) if a company goes bankrupt. They often pay a guaranteed dividend for life. Frequently the issuing company has the right to buy back their preferred stock at any time for a premium. One downside of being a preferred stock holder is they usually come with a lack of voting rights. Examples of companies currently issuing preferred stock are:

MBNA ? Ticker: KRB-B, KRB-C
TransCanadaPipelines ltd – Ticker: TRPPR
Merrill Lynch ? Ticker: MER-B, MER-C

Market Exchanges: Home of Shares
Exchanges are where shares are traded, i.e. where buyers and sellers meet to decide on a price for a share. That doesn?t mean you have to go down to the exchange yourself; your orders are sent via your broker to the exchange where orders are matched. The two major exchanges in the US differ slightly in the way they operate. They are the NYSE and the NASDAQ.

The NYSE The New York Stock Exchange is the oldest exchange in the US and the most highly regarded in the World. It is home to many of the US and the World?s largest and most famous companies such as McDonalds, Coca-Cola and Citigroup as well as the DJIA and S&P 500 indices.

The NYSE is still a listed exchange. By this we mean buyers and sellers are matched by floor traders with the help of computers. This means that executions are slightly slower than those conducted at virtual exchanges which are totally computer run.

You have probably seen the floor of the NYSE at some point during your life on the news or if you tune into Bloomberg TV. You will notice the floor traders waiving their arms around frantically at trading posts which is where each company trades. Think of the NYSE as a huge auction room with one major difference: in stock auctions prices aren?t constantly being bid higher, they are being offered lower too!

The NASDAQ The National Association of Securities Dealers Automated Quotations is the major over-the-counter (OTC) exchange. This means that it is more of a ?virtual? exchange in as much as there are no floor traders or even a floor. Dealers using a sophisticated network of computers match orders.

The technology boom of the 1990s has been a huge boost to the NASDAQ. It is now home to some of the largest companies in the World such as Dell (DELL) and Microsoft (MSFT). Previously OTC exchanges had only been used by smaller companies but this all changed with the massive value expansion of the tech. sector. The exchange is also very popular with the Internet Sector; Google, Ebay and Yahoo are all listed on the NASDAQ.

On the NASDAQ, brokerages act as market makers. The role of the market maker is to match buyers and sellers for a particular stock. They must maintain a quote at all times (a bid and ask) with a defined spread, although this spread can alter slightly depending on market liquidity conditions.

The Rest of The World Nearly every European capital city has its own stock exchange, the largest of these being the London Stock Exchange or LSE. The LSE is home to large British companies such as Tesco and also multinational corporations who have listings on more than one exchange in the World such as HSBC for example.

The Tokyo Stock Exchange is Asia?s largest exchange. It includes companies such as Sony Corporation and Konica Minolta Holdings, INC. The Tokyo Stock Exchange closed its trading floor in 1999 and realigned itself as an OTC exchange.

What Makes Share Price Move: Demand and Supply Basics
The prices of the shares listed on the major exchanges are changing constantly during market open hours. They are moved by the orders from individual traders through to large banks and institutions. The basic concept that determines these price fluctuations is that of demand and supply. To put it simply, if more people want to buy stock XYZ than sell it price will rise, conversely if more people want to sell the same stock than want to buy it price will fall. This is a pretty basic interpretation and it fails to consider the factors that contribute to these buying and selling decisions.

Fundamental Traders Fundamental traders are people who make their decisions based on market, sector and stock specific news. For example, in an expanding economy, a bullish sector and with an excellent earnings report from a specific stock a fundamental investor will probably choose to open a long position or add to the position he/ she already has. This exceptionally likely if the current price trend is up; as the old adage goes: the trend is your friend. The fundamental analyst would see this positive news as a sure sign that price will move higher. After all this news is sure to increase the demand for the stock and decrease the supply.

The problem with fundamental analysis in its most basic form is that it doesn?t take trader psychology into consideration. What we mean by this is the impact that fear and greed will have on price cannot be measured. An example of this would be a highflying stock, such as one of the Internet stocks during the boom in the late 1990s. All fundamental reasoning for prices to reach as high as they did went out of the window. Share prices were over valuing companies who failed to make any profit. Price was in fact being driven higher by greed. Everyone wanted to invest in these stocks and make a fortune. As soon as the price stopped rising and began to fall the human emotion of fear kicked in sending share prices into a rapid decent.

Technical Traders Strictly technical traders completely ignore the fundamentals and stick to spotting price patterns. Technical traders argue that price patterns mimic the psychology of the market?s participants. By spotting patterns that have occurred multiple times throughout charting history a technical trader will aim to put the odds of being able to pick a profitable position in his/ her favour. Of course no technical patter is 100% guaranteed to repeat itself every time and technical traders often find their analysis undone by unexpected fundamental reports such as earnings or legislation releases.

Combining the Two Most successful traders will tell you that they have found a happy medium between trading both fundamentals and technicals. This means that they are aware of company earnings and the business environment but wait for key technical levels before making their trades. Professional traders always have a clear, definable method for their entry and their exit, stick to their trading rules religiously and ignore their emotions. It is this discipline and consistency that breads success.

Always keep in mind that everyone has slightly differing views on where a particular stock is headed, how quickly and how far it will go. If everyone had the same idea then the market wouldn?t exist at all. That is why it is so important for you to learn to trust your judgement.

A Company?s True Value
While reading through a list of quotes in your daily newspaper or online you may be forgiven for thinking that the companies with the highest priced shares are worth more than those with a lower stock price. This is not the case. A company?s current market value is calculated in terms of market capitalization. This is calculated by multiplying the number of outstanding shares by the current price per share. A good example of this is as follows:

At the time of writing Google (GOOG) has a share price of $375.39. Therefore it will cost you $375.39 to buy one share in Google. At the same time Microsoft (MSFT) has a share price of $24.21, much lower. So which company has the greatest value? The answer, maybe surprisingly (when looking at the share price anyway!) is MSFT. Microsoft has a market capitalization of $243.6 Billion compared to Google?s $113.78 Billion. The reason for this is of course the number of shares in issue. To put this into perspective the average daily volume (number of shares changing hands every day) for Google is almost 7 million compared to more than 82 million for Microsoft.

Keeping in Touch With The Market
We don?t want to go into too much detail about how to choose the shares you wish to invest in but here are a few brief pointers:

Choose a company you have had many experiences with, possibly even on a daily basis. If you love their customer service and efficiency the chances are others will too.

Do your research. The Internet is an invaluable source of information. Most companies will often have an ?investor relations? page keeping you up to date will past, present and future performance and news.

Take your time. Don?t rush into anything, the market was there yesterday and it will be here tomorrow. Make sure you understand the ins and outs of what you are doing and feel confident in your trading or investment plan.

We have already written about the power of the Internet when researching your potential investments but it is also an excellent means of keeping track of the day-to-day price movements. You can log on to http://www.NASDAQ.com http://www.nyse.com or http://finance.yahoo.com/ where you are provided with slightly delayed market data and news releases. This is by no means sufficient for the active day trader but it is enough information to keep most people up to date.

Trading Vs Investing
The difference between trading and investing is quite a large one. An investor is someone who buys shares in a company with the intention of holding onto them for a period of years (all things being well). Therefore an investor is relatively uninterested in daily price fluctuations and will be paying much more attention to press releases, earnings reports and news items concerning the companies they have invested in. On the other hand a trader can open and close a position in a matter of seconds or hold on for several months. A very active trader (seconds, minutes, hours) is known as a day trader while the less active (days, weeks, months) are swing traders.

Investing and trading can both be highly profitable pursuits but you should consider several factors before deciding which path to follow. For example, if daily price fluctuations make you nervous you should probably stay away from day trading and move towards investment or longer term swing trading. Day trading is for those who can stay detached from their emotions and want to make trading a full-time job.

Choosing a Broker
There are two different types of broker that will enable you to buy and sell shares, full-service and discount.

Full-Service: The first brokerages on the scene were mainly full service. These brokerages can actually manage your account for you and recommend certain investments. The fact of the matter is that these brokerages are very expensive and you lose control over your own investments.

Discount: Don?t be put off by the name, discount doesn?t mean ?cheap and nasty?. Discount brokers exploded into the market place with the arrival of the Internet. Rather than offer you advice and mange your account, you are free to do this via an online trading platform. Your discount broker makes their money by charging you commission costs for any trades you execute. The rate of these costs depends on how often you place trades.

When you come to open your first brokerage account you must do your due diligence so you avoid any unnecessary costs or wasted time. By the time you come to open your first account you will probably have a good idea of how active you will be and therefore the commission costs you should look to pay. Internet forums are an excellent source of independent reviews and experiences that will help you find the best brokers in a highly competitive market.

The difference between trading and investing is quite a large one. An investor is someone who buys shares in a company with the intention of holding onto them for a period of years (all things being well). Therefore an investor is relatively uninterested in daily price fluctuations and will be paying much more attention to press releases, earnings reports and news items concerning the companies they have invested in. On the other hand a trader can open and close a position in a matter of seconds or hold on for several months. A very active trader (seconds, minutes, hours) is known as a day trader while the less active (days, weeks, months) are swing traders.

Investing and trading can both be highly profitable pursuits but you should consider several factors before deciding which path to follow. For example, if daily price fluctuations make you nervous you should probably stay away from day trading and move towards investment or longer term swing trading. Day trading is for those who can stay detached from their emotions and want to make trading a full-time job

Conclusion
This is what we have learned over the course of this tutorial:

Ignore the hearsay ? Don?t become involved in the ?heard mentality? of the general public. Take your time to learn about the inner workings of the stock market and develop your own trading plan.

Stock, share, equity ? All of these terms mean the same thing and ownership of them entitles you to voting rights and dividend payments.

Why do we have stocks? ? Stocks are issued to raise money for a business, this method is known as equity financing.

Preferred or common stock? ? Preferred and common stocks have different characteristics. Most of the investment decisions you come to make will involve common stock.

The Exchange ? There are two major types of exchange, listed and over the counter.

Supply and demand make the market move ? Supply and demand are governed by fundamentals, technical and trader psychology.

A company?s true value ? Market capitalization is the true value of a company and not share price.

Keeping in touch ? You can use the Internet to great effect when you wish to research and keep in touch with your investments.

Trading Vs. investing ? The type of market participant you become depends heavily on your spare time and your emotional attachment.

Choosing a broker ? Whether you want to invest or day/ swing trade will determine the broker you want to use. Remember due diligence is key.

David Thorpe writes articles for http://www.passion-trading.munbuns.com This site is dedicated to bringing its visitors free resources that will allow them to develop their learning and better manage their own money in the financial market.Born in Somerset, England in 1982 he began his independent trading career at the age of 20. David now has four years of experience with foreign exchange and stock market trading. All of the knowledge he has gained has been down to his research and daily experiences with the market. Mr.Thorpe can be contacted at ptsupport@munbuns.com

David Thorpe writes articles for http://www.passion-trading.munbuns.com This site is dedicated to bringing its visitors free resources that will allow...

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Junior member
45 5
Page 2 mentions OTC market makers "On the NASDAQ, brokerages act as market makers."

Later the article describes brokers as either full service and discount.

I'd like a little clarity about brokerages vs brokers. From the article I'm left thinking that they are same.

A nice overview. Still quite a few typos.