Investing: A Primer for BEGINNERS. Part 4

All You Really Need To Know About the STOCK MARKET

Many people are intimidated by the stock market. There's really no need to be; it's quite simple.  

Well, on the face of it, it's simple, but the deeper you go, the more complex it becomes. In this article, we'll start with the simple concepts, and leave the complex stuff for later articles. 

What is STOCK?

Let's start with an understanding of what stock is. Simply put, when you buy a share of stock, you buy a share of ownership in a company.

Businesses form corporations for legal reasons (for example, there are lots of tax benefits available to corporations that aren't available to individuals). There are several types of corporations, from privately held corporations to limited ownership corporations to publicly held corporations. We're talking about the last type here.

When a company (corporation) decides it wants to expand and needs a lot of money to finance the expansion, it will issue shares of stock and sell these shares to the general public, in what's called an initial public offering, or IPO. Occasionally, they will issue additional stock after the IPO. Regardless of when they are issued, each share of stock represents one piece of ownership in the company.

Here let's look at some examples to see what we are talking about. 

Let's say a very small company issues 1,000 shares of stock at $100 per share. The original owner of the company retains 510 shares of stock for his own ownership position. That means he would still own 51% of the company. That also means they would sell 490 shares of stock, raising $49,000 for the company treasury. 

Larger corporations have issued literally millions of shares of stock. Sometimes a majority shareholder will own as few as 3% of the shares. 

But the bottom line is that if you own even one share of stock in a company, then you own a piece of that company.

What does stock ownership entitle you to? 

When you own a share of stock, you can either keep it or sell it.

If you keep it, then you are entitled to participate in and vote in stockholders' meetings. Most companies have a stockholders' meeting annually. If you own shares of stock in a company, they should send you an annual report and notice of shareholder meetings. Most stockholders do not attend these meetings, but instead vote for a proxy to represent them at the meeting.

Also, if you own stock, it entitles you to receive dividend payments, if the company issues them.

Dividend payments occur when the company makes a significant profit, and decides to distribute some of the profit to its owners. Other companies do not offer dividends, instead choosing to invest all profits into the expansion and improvement of the company. 

That's about it. As a stockholder, you don't get to tell them how to run the company, or to sell or buy equipment, or worry about what products they make or services they render. All you can do is vote in stockholder meetings.

What IS the Stock Market?

The stock market is a centralized location where people gather to buy and sell stock. 

Actually, there are several of these centralized locations worldwide, the AMEX (American Stock Exchange), the NYSE (New York Stock Exchange), the NASDAQ (National Association of Securities Dealers Automated Quotations) and the international exchanges, like the NISSEI in Tokyo. 

You can read more about what the stock exchanges are at

http://en.wikipedia.org/wiki/Stock_exchange

When corporations issue an IPO, they will either register with one of the major exchanges, or they will remain independent, preferring that their stock be traded "Over The Counter," as the NASDAQ does.

As far as beginning investors are concerned, you don't need to worry too much about which exchange a stock is listed with, because your broker will handle all the details.

Why Do I Need A Broker?

Individuals are not authorized or licensed to deal directly with the exchanges, although in some cases you might be able to purchase stock directly from a company.

Instead, you will need an authorized and licensed person to buy and sell the stock for you. We will discuss brokers in a future article. 

For now, all you need to know is that some brokers offer good advice, some offer bad advice, some offer no advice at all. But all of them charge for their services, usually a commission based on the number of shares you trade, or the amount of money involved.

Why do Investors Turn To The Stock Market?

The main reason investors turn so quickly to the stock market is that it's so readily available. People know a lot about the surface of the stock market, and it's in the news almost every day. Rare is the person in the U.S. who hasn't heard of the stock market crash of 1929, and how it heralded the beginning of the great depression. 

The stock prices for most major corporations are readily available daily, either on line or in any major newspaper. 

People can easily make a purchase, easily follow how their investment is doing, and easily get out of it when they want to retrieve their money. 

And mostly because it's easier to understand than most other investments.

How Do You Make Money (Or Lose It) In The Stock Market?

This one's simple. To make money, buy low, sell high. To lose it, buy high, sell low. 

If you buy 100 shares of ABC stock at $10 a share, you would spend $1,000. If a year from now you sold those 100 shares for $15 a share, you would realize $1,500 on the sale, for a $500 profit, and a 50% return on your money (less the broker's commissions).  

Of course, if it were that simple, everyone would be rich from the stock market. As you have surmised, it's not that simple.

If you want to make money in the stock market, then you have to learn something about the forces that make stock prices move. Your goal, of course, is to purchase the stock when you think the price is going to go up, and sell it before the price starts going down.

We will be getting into what these forces are in a future article. and we will also talk about how to do analysis of these forces, so you can at least have a fighting chance of making money, not losing it.

What Other Things Do I Need To Consider When Investing In Stock?

The main thing to keep in mind is that when you make a trade (buy or sell stock), you will usually pay a broker's commission. 

This is just one of the costs of doing business in the market, and unless you go overboard in making trades, this expense won't be too bad.

However, if you do go overboard, or if you have a disreputable broker, then the brokers' commissions will eat up all your profits, and probably even eat into your equity. 

So don't let the fear of paying a broker's commission deter you from making a trade you really feel is essential, but keep in mind that if you trade too often, the commissions can become steep. 

What Causes Stock Prices To Change?

This question is more appropriate for an entirely separate article, but let's cover the basics. 

The ONLY thing that causes a stock price to change is the law of supply and demand. 

It's not (directly) the profitability of the company, the honesty of its officers, the size or growth of the company, the demand for its products -- none of this directly impacts the price of a stock.

However, they can influence the demand for a stock, and when the demand goes up, then so does the price. 

Stock is a limited supply item. There's usually enough of it floating around for any large corporation that you should be able to buy it or sell it whenever you want. But when more people want to buy it than sell, those who do have shares to sell can ask higher prices. And get them.

And the reverse is also true.

If a large number of people want to sell a stock, and very few want to buy it, then the price will come plummeting down as the sellers compete with each other for the available buyers.

A vivid example of this is what happened to the stock market immediately after September 11, 2001. To the right is a graph of what the Intel Corporation (INTC) did in 2001.

Notice the nosedive the stock took in the September timeframe, losing almost a third of its value. Many U.S. stocks exhibited this same behavior. Why? It wasn't because they suddenly quit operating, or suddenly had low profits or bad products, and it wasn't because their officers suddenly became untrustworthy.

No, the only reason for the stock price nosedive in September of 2001 is that investors suddenly wanted to get their money out of the stock market. There were thousands, probably hundreds of thousands more sellers than there were buyers. 

When this happens, the law of supply and demand dictates the prices will fall. And they did. 

Any savvy investor with some cash to spare at this time, would have waited until the price fall stopped and started back up, then would have invested heavily in any reputable corporation. 

From the chart above, you can see that Intel not only came back, but came back to a higher level. That savvy investor would have made 50% on his money in only a few short months.

To answer the main question of this section, "What causes stock prices to change?" The main answer is Investor Perceptions, and the technical answer is the law of supply and demand. 

We will get more into this in a future article.

How Can I Be Sure I Make Money, Not Lose It?

Ah, yes. The quest of all investors. I'll address several future articles to some things you can do to give yourself the best chance of making money, and not losing it. 

But as with all investments, you will always have an element of risk, so be sure to always heed this advice: Never invest more money than you can afford to lose. 

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That's enough for now. In the next part, we'll talk about some of the types of analysis you can do, so you'll know (more or less) what to expect from the stock market.. 

If you'd like to ask me a question, please use the Snicko contact page. I read them all, and I'll try to answer the most pertinent ones in this series of articles. 

Take care, and God Bless,

David