Are you considering investing in the stock market, but you’re not sure where to get started? It’s understandable. There’s a lot to figure out.
Here’s just a sample of some of the questions you might have:
- How does one make money on stock?
- What are the different types of stock and how do they compare?
- Can anyone trade on the stock market?
There’s also a fair amount of jargon to get through. You might think that bulls, bears and candlesticks only go together in some sort of surrealist fairytale, but they all have their home in the vocabularies of day traders.
With a little breakdown, this doesn’t have to be confusing. This post aims to give you the lay of the land and maybe even point you in the right direction if you want to do some trading of your own.
Before we get into it, it should be noted that as with any investment vehicle, the stock market comes with its own set of risks and rewards, pluses and minuses, some of which we’ll get into below. You should always be aware of your own comfort level with investments and not go beyond that level. A financial advisor can help you with planning and determining the right strategy based on your risk tolerance.
There’s no better place to start than at the beginning, so let’s get going.
What’s a Stock?
In its simplest terms, a stock is just a share of ownership in a company or corporation. There are two different types of stock: private and public. Within public stock, there are a couple of further distinctions, but let’s start with the difference between private and public.
Private
Private stocks are ones that the public at large doesn’t have access to. These shares are typically limited in number. For example, a privately held company might have two cofounders and two investors. They may each have a share worth 25% of the value of the company.
If a business remains privately held, shares may only ever be given to investors and employees.
If a company wants to grow and its private investors don’t have the money to finance the expansion, it may turn to the public to invest rather than getting a loan. Let’s go over that next.
Public
As the name suggests, publicly held stocks are owned by shareholders in the general public rather than only being held by those in the company itself.
When a company first goes public, it does what’s called an initial public offering (IPO). The company, together with an underwriter, says it will make a certain number of shares available at a given share price. This is done through an investment bank that helps determine a company’s financial health.
The bank’s job is to make sure that the company will continue to be viable after the public invests. During an IPO, the bank acts as a broker between the company selling the shares and the buying public.
There are a variety of factors that go into determining the initial share price, including something called a roadshow, where companies pitch to investors and get a sense of market appetite. The conditions in financial markets also play a role.
Types of Public Stocks
After the company has gone public and people have bought initial shares, how is money made by the investor? There are couple of ways. Let’s break down common and preferred stock as well as discussing classes of stock
Common Stock
It’s a good bet that when most people think of stock, this is the type they think of. They buy shares in a company, say Dunder Mifflin. In exchange, they get a stake in the company proportional to the number of shares they have.
You make money on common stock in two ways. If the share price goes up (we’ll get into reasons for stock movements in a minute), you could sell some or all of your shares in the company at a profit, compared to when you bought them.
The second way an investor can make money is through a dividend. A dividend is a payout to shareholders. Let’s say high demand for white cardstock led to a very profitable quarter for Dunder Mifflin, and the company has decided to share that bounty with its shareholders.
While companies that issue common stock can offer a dividend, they aren’t required to and often don’t. If you want a steady payback on your investment, one of the things you can do is take a look at how often any particular company has paid out a dividend and in what amounts. Another avenue for more regular revenue would be the preferred stock discussed below.
Common stock also typically (but not always) comes with voting rights. Investors can have a say in the management of the company that’s proportional to the number of shares that they have. If enough shareholders don’t like the way things are going, they can have the leadership of the company forced out. It’s one of the risks companies take when they go public. We’ll talk about how some companies choose to get around this while still selling common stock in a minute.
Preferred Stock
Preferred stock functions a little more like a bond than a traditional stock. In return for an investment in the company, holders of preferred stock are guaranteed a dividend for as long as they hold the stock. This dividend is paid out at a fixed rate.
Unlike common stock, holders of preferred stock don’t get voting rights in the companies they buy into. Preferred stock can be bought back by the company that issues it at any time, depending on the way the shares are set up. These are typically bought back at a higher price so the investor profits.
Now that you know the difference between common and preferred stock, let’s go one level deeper.
What Are Classes of Stock?
You may have heard or seen in the news references to Class A stock vs. Class B or C, etc. What does all that mean?
Classes of stock refer to the different voting rights you have associated with the type of stock you purchase. A company can create a new class of stock and determine how much voting power and how much worth the stock has compared to its primary stock. A good example of this is Berkshire Hathaway stock, which is divided into A and B classes.
Billionaire investor and CEO of Berkshire Hathaway, Warren Buffett, wanted to enable everyday investors to get in on his stock while not splitting the existing stock (making one existing share worth two or three shares, etc.). While splitting stock can attract new investors, it can also encourage speculative investment from those looking to make a quick profit by buying into the new, cheaper stock and getting out a short time later after making a quick profit when the stock goes up. If enough people were to sell too quickly, it could seriously devalue the stock.
Buffett chose to avoid this problem while still encouraging new investment with A and B classes of stock. The B Class is worth a fraction of the Class A stock. In the case of Berkshire Hathaway, a Class B voter has an even smaller fraction of the voting rights a Class A shareholder would have.
One of the primary motivations for the creation of different classes of stock is to retain control of your company while encouraging new investment because you can control what the votes are worth, if you allow voting at all.
Now that you know the different types of stock and how they work, let’s break down what makes the market tick.
How the Stock Market Works
In this section, we’ll take a look at the basic mechanics of how the market works and its wider effects on the economy.
What Causes Stocks to Go Up and Down?
There are a number of factors that can affect the movement of stocks in one direction or another, but the most basic concept to keep in mind is the law of supply and demand, which is as active here as it is anywhere else in the economy.
When there’s lots of demand for a stock and few sellers, the price is higher. If things are moving in the opposite direction, the price is lower. But what drives demand? Some things come down to hard data and some of it is investor speculation and gut feeling.
Let’s take Apple, for example. Sometimes stock movements can be tied directly to hard, verifiable news like the announcement of a new iPhone.
Sometimes stock movement can indicate satisfaction or dissatisfaction with leadership. Steve Jobs once sold 1.5 million shares of his own Apple stock, which led to the firing of then-CEO Gil Amelio to make room for Jobs. (Jobs didn’t reveal he was the seller until later on.)
Even huge companies like Apple don’t make announcements every day or even on a regular basis, though. Earnings reports only hit once a quarter. Therefore, a lot of what makes stocks move on a day-to-day basis might have to do with the direction of the market as a whole. If stocks are going up that day, many times companies will benefit from the increased appetite for stocks in general.
Sometimes, companies are impacted by forces that are even beyond their control. Samsung could have issues making screens and that could delay the release of the iPad with negative effects on the stock price. Increased or decreased taxes on imported components of the device could impact the price and sales of a device, which in turn could sway the market feeling about a company.
In short, there’s a lot that could impact the stock price of a particular company.
How Is The Stock Market Affected by the Economy?
As we mentioned above, one of the things that happens with the stock market is that economic reports can cause people to have greater or worse feelings about the market or economy as a whole beyond what might be happening with individual companies that they’re invested in.
If people see that companies are doing more or less manufacturing, or hiring more or fewer people, that can influence the way people feel about the economy. If people think things are good, they tend to buy stock on the thought that companies are hiring (or doing more manufacturing, which leads to hiring because people are needed to make things) which gives people jobs and disposable income. People with disposable income buy more goods and services, which is good for company stocks.
When people are feeling less optimistic about the economy – because of a bad report or new tensions between countries, for example – people often buy bonds. The main challenge with buying bonds is making sure your investment keeps up with inflation. The advantage of bonds is that while the return may or may not be as high as it would be in the stock market, they offer a guaranteed return.
How to Read Stocks
When looking for a stock, the first thing you need to know when reading these things at a glance is that each company trades under specific symbols. If it’s an international corporation, it may trade under different symbols in different parts of the world.
Let’s say you’re interested in investing in Nike. If you look that up, the stock symbol is NKE on the New York Stock Exchange (NYSE). The first number you’ll probably notice on any financial news site with a stock tracker is the current share price. In the United States, this is measured in dollars and cents, but the units may vary depending on where in the world you’re investing. In London, for example, they measure stock prices in pence.
You can also typically tell how much the stock is up or down on the day in terms of both points and as a percentage of its total value. The last really basic metric is how much the price is up or down on the year.
If you’re looking at a decent source, you should be able to get an idea of the performance of the company over the past day all the way back to the past 10 years if the company has been on the exchange for a while. You’ll also be able to tell how active the stock is for a given period based on how often it gets traded. You figure this out by looking at the volume number.
What Is a Candlestick Chart?
If you really dig into the data, there are a lot of data points you can use to figure out how a particular stock is trending. One useful item for you might be a candlestick chart.
A traditional line graph shows very high level performance of a stock. A candlestick chart takes things a step further by showing you the actual buying and selling patterns.
Image: Probe-Meteo
A candlestick is represented by a vertical line and a box. In a candlestick chart, one candle represents each day in the market.
The vertical ends of this box represent the movement of the stock between where it opened and where it closed. In some representations, upward movement on the day is shown by a green box, while a red box will represent a stock that ended the day lower than it started. If the graphic is black and white, a stock that was pushed up on the day by buyers will have its rectangle unfilled. If selling pressure pushed the stock lower, the same rectangle would be filled in.
Outside the box, the vertical line represents the high and low points of the day for the stock. If there’s quite a bit of space below the box, you can tell there was a lot of selling pressure on the stock for much of the day before it went up to settle where it did. On the flip side, if there’s a lot of line above the box, buyers were pushing the stock hard at points during the day.
Candlestick charts can be useful for detecting patterns over time, but they don’t tell you why a stock moves the way it moves. To get more info, try looking at any news coverage around any potential investment.
If you want to go deeper, this is a great overview of candlestick charts.
Exchanges and Indexes
There are stock exchanges and indexes in the United States and throughout the world. This section will go over the major ones to know about and some key terms you’ll hear.
What Are the Major Stock Exchanges in the United States?
When people refer to the stock market in the United States and talk about its movements, they’re either discussing the NYSE and Nasdaq (National Association of Securities Dealers Automated Quotations), or one of the major indexes like the Dow Jones industrial average or S&P 500.
The stock exchanges are the actual markets on which company shares are traded. The NYSE is an auction market, meaning individuals on the floor are buying and selling from one another. On the Nasdaq, stocks are purchased through a dealer who acts as the market maker.
Another key difference is that the NYSE has an actual physical trading floor in the city. It’s the big space with the bells and the organized cast of traders shouting buy and sell orders all over the room. The Nasdaq is just a telecommunications network and trades are made from all over the world.
The Dow Jones industrial average is based on the price of 30 of the most important companies on the NYSE and Nasdaq. It’s a good indicator of the direction of the overall market.
The S&P 500 represents 500 companies that have some of the largest market capitalizations in the U.S. Market capitalization is calculated by taking a company’s share price and multiplying it by the total number of shares owned by all investors.
What Are the Major Stock Exchanges in the World?
While the NYSE and Nasdaq are the biggest markets in terms of market capitalization, the United States certainly isn’t alone. The top five stock markets in terms of capitalization are:
- NYSE
- Nasdaq
- Tokyo
- London
- Euronext (European Union)
How to Play the Stock Market
Now that you know the basic principles of the stock market, how do you actually get in on the action? That’s a loaded question, particularly if you’ve never done anything with stocks before, so let’s start at the beginning.
What’s Your Trading Budget?
As with any investment strategy, you need to give yourself a budget for your stock investments. If you’re just getting started, maybe you’ll make this budget based on some extra money you have. The stock market and the individual stocks you pick can go up, but they can also go down. Any investment has risks, and you might lose some money. It’s always advisable not to put all your eggs in one basket.
Once you have a budget that you’re comfortable with, we can move on to the next big question.
How Do I Buy Stock?
You can’t call up Microsoft and say you want to buy 10 shares at the current price. Companies aren’t set up that way. You need to go through a trader with access to the exchange. The traditional way of doing this is to go through a stockbroker.
Buying Through a Stockbroker
A stockbroker is someone who has the ability to make trades for you on the stock market. If that person is also a financial advisor, they’ll sit with you and go over your goals and aspirations, your financial profile and your tolerance for risk.
If you buy through a broker, ask them how they get paid. Some charge a fee for the trade. On the other hand, they may also be paid a percentage of your investments. This can encourage responsible management because they do well when you do well.
Do You Have to Go Through a Broker to Buy Stock?
The short answer is no. Although buying through a broker is common, there are alternatives. There are online stock trading platforms that will help you place your orders. These places have a standard fee for processing your buy and sell orders most of the time. However, it’s possible to find platforms that are fee-free.
Whatever platform you sign up with, do some looking into how they make their money. That way, you know what to expect going into it.
How Do You Make Money in the Stock Market?
Knowing the answer to this question could have a really good impact on your bank account. If we really get down to the simplest explanation, it all comes back to buying low and selling high. That’s way easier said than done, so maybe we should back up a bit.
If you just start out with investing in stocks, you’ll probably want some sort of plan of attack. Everyone is different, and we’re not investment advisers. What we can do is offer some general ideas.
We’ve mentioned Warren Buffett once in this post already. You don’t become a billionaire investor without making some smart investments along the way. So when the Oracle of Omaha visited Quicken Loans, what advice did he share? Find your passion.
When investing, look to get in with stocks in the areas you typically follow and have an interest in. If you’re already reading news and keeping up on these things anyway, it’ll make it that much easier to keep up on your investments. If you have expertise through interests or work, you likely know enough about the sector to make intelligent investments.
No one can predict the future, but if you follow a particular space, you may have a better idea of who is up and coming, and what companies have performed well in the past. As with other investments, there’s no substitute for education and research. But there’s also no magic bullet.
If you’re thinking about investing in stocks, but aren’t sure if you’re ready, we invite you to check out our Fantasy Stock League. You can play for free, giving you a chance to hone your skills and maybe even win prizes.
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