Stock Market Basics

October 4, 2008

This post is for the stock market beginners or those needing a refresher course in stock market fundamentals. Let’s first start with defining what exactly is a stock. A stock is basically a small share or interest that represents a partial ownership of a company. Stocks are issued by companies in order to raise capital and are bought by investors in order to acquire a portion of the company in the form of investment. Even a small share or interest in the company will give the investor the right to have a say or vote in how the company is run. Although investors do gain a portion of the company’s profits, investors do not carry liability in case of lawsuits or defaults. Stocks allow for cash infusion and stock issuance is typically needed for start-up capital, acquisition or company expansion and or growth. Each stock is limited to a particular number of shares available for issuance. A company’s growth potential and perceived health of the company influences the market adjustment of the initial value or “par value” of the stocks.

Obviously investors purchase stocks with the idea that the company will grow and ultimately raise the value of the purchased shares. Acquiring stocks from a new company or start-up is somewhat more risky than buying shares from an established company, but the potential gain is much greater.

Only companies which are listed with the public exchanges like the US Exchanges, NYSE (New York Stock Exchange) or NASDAQ (National Association of Securities Dealers Automated Quotation System), are capable of stock trading. The shares from the companies listed on public exchanges can be bought and sold on the open market.

An individual investor typically hires a broker to make transactions for him. Or now with the internet an investor can bypass the broker and use an online broker company such as Scottrade.com, Etrade.com or Zecco.com. The orders can contain specific instructions to trade at a price that the market will bear or at a price that the investor will prefer. The broker then tries to execute the investor’s orders by searching for either a buyer or a seller. In return the brokers or exchange houses will typically receive a commission on each trade. Some online brokers such as Zecco.com will allow for 10 free trades per month and then a flat fee of $14.95 per trade thereafter that month.

Stocks have a lot of advantages over savings investments because they represent ownerships in a particular company. This gives the investor a certain right to participate in making decisions for the company. Some important company matters require voting and one stock is equivalent to a single vote. Partial company ownership also allows the stockholders to benefit from the company’s profits which are distributed in the form of dividends. These may be issued one or twice a year at the discretion of the company directors.

A prospering company causes the value of the stocks and the profits to increase while a suffering company causes the value of the stocks and the profits to decrease. Stocks, when compared with savings investments, both carry a higher risk of losing money and a higher potential of earning money. A good knowledge of the different stock markets and the various investment strategies can help investors to minimize their losses. Knowing when to enter and exit a market is critical to maximize returns.

“Stock market” is a term used to describe the physical location where the buying and selling of stocks take place as well as the overall activity of the market within a particular country. The correct term to be used in pertaining to the physical location for trading stocks is “stock exchange.” Every country may have a couple of different stock exchanges that are usually traded on only one exchange although a lot of large corporations may be listed in several different locations. For example India, Canada, Japan, China and several other countries all have their own stock trading exchanges.

The ubiquity of these international exchanges makes it possible to buy or sell stocks throughout the world. The only restriction to stock exchanges is time. Different exchanges may have differing opening hours based on their local times. The major global stock exchanges are the Tokyo Stock Exchange of Japan, the Bombay Stock Exchange of India, the London Stock Exchange of United Kingdom, Frankfurt Exchange of Germany, the SWX Swiss Exchange of Switzerland, the Shanghai Stock Exchange of China, and the NYSE, the NASDAQ, and the AMEX of USA.

The economic health of a country is closely followed by stock markets. The term “Bull market” is referred to as an up economy when a country experiences high economic production, low unemployment level, and low inflation rates. “Bear markets”, on the other hand, follow the down trends in the economy. Such indicators of economic downturn are high levels of unemployment and high inflation. Supply and demand which are affected by consumer and investor psychology also influence the prices of stocks.

Aside from the stock exchange, other popular markets that offer many investment opportunities include currency trading via the Foreign Exchange Market (FOREX). The FOREX is the biggest investment market in the world, in terms of trades and overall values.

Other trading options include futures and options. The futures market is a market of contracts where goods are bought and sold at specified prices and times.
The options market is very similar to the futures market because it also features a contract that gives the right, and not the obligation, to trade a stock at a certain price before a designated date.

Stocks can be bought and sold by anybody who has money. Knowing the basics will help people understand how stock trading works despite the process’s own specialized vocabulary. People who have knowledge about stock trading are the ones who are most likely to be successful in the investment industry.

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