THE STOCK MARKET INTRODUCTION

Transcription

1 Document2 Page #1 THE STOCK MARKET INTRODUCTION Right now, the New York Stock Exchange has billions of dollars changing hands every day, with thousands of companies being traded, and millions of people being affected, if we trace the roots of the New York Stock Exchange to its beginning, we would find that it started out as dirt path in front of Trinity Church in East Manhattan 200 years ago. At that time, there was no paper money changing hands, or even the idea of stocks. Rather, they traded silver for papers saying they owned shares in cargo, which was coming in on ships every day. The trade flourished. During the American Revolution, the Colonial Government needed money to fund its wartime operations. One way they did this was by selling bonds. Bonds are pieces of paper a person buys for a set price, knowing that after a certain period of time, they can exchange their bonds for a profit. Along with bonds, the first of the nation s banks started to sell parts or shares of their own companies to people in order to raise money. In essence they sold off part of the company to whoever wanted to buy it, which is the essence of the modem day stock market. THE BEGINNING Wall Street was becoming a major center of these transactions, and in 1792 twenty four men signed an agreement that started the New York Stock Exchange (NYSE). They agreed to sell shares or parts of companies between themselves and charge people commissions, or fees, to buy and sell for them. They found a home at 40 Wall Street in New York City. As they grew they later moved into what is currently the New York Stock Exchange Building. The 1900s brought the Industrial Revolution, and along with it, a boom in Wall Street. Everybody wanted a piece of the action, and Wall Street grew. The New York Stock Exchange was not the only way to buy stocks at that time. Many stocks that were deemed not good enough for the NYSE, were traded outside on the curbs. This so called curb trading, has now become the American Stock Exchange (AMEX). Today, the New York and the American Stock Exchanges have been joined by the NASDAQ, and hundreds of local and international Stock Exchanges, that all play a part in the national and global economy. HOW IT WORKS Let s say you hear a tip that McDonalds is coming out with a brand new product that is supposed to double their business. You think to yourself, Darn, I wish I owned that company. Well you can. McDonalds, along with thousands of other companies, lets the public buy part of its company. It does this through selling shares. A share is simply a piece of paper that says you own part of a company. This part is usually extremely small, perhaps thousandths of a percent of the total company, but, hey, it is a beginning. You decide you want to buy part of McDonalds. You run home, and count up all of the money you have been saving, and find out you have 250 dollars. Well you are not going to be able to buy the whole company, but it is a start. You ve got the money, you know what stock you want to buy, now what? Do you go to the grocery store and ask for a dozen shares of McDonalds, not exactly, but close. You don t go to a grocery store, but rather you call a broker. A brokerage house is your supermarket of stocks. You call up any broker and say, Charles, I ve got 250 dollars, and want to buy as much McDonalds as I can. Charles in return tells you, Let s see, a share of McDonalds costs 20 dollars (Not the actual price), and am going to charge you 50 dollars for my services, so you can buy 10 shares of McDonalds. You then give Charles the money, and you get the stock. (They usually don t give you the paper stock certificates, but they transfer ownership over to you.) Voila, you have just bought stock in a company!

2 Sounds simple enough, right? Actually it is not if you look at it from the broker s point of view. When you told the broker you wanted those 10 shares of stocks, he did not magically buy them for you, or already own them. Rather, he sent a message to another person who is working down on the floor of the New York Stock Exchange (or any other stock exchange). He tells this person to buy these stocks for you. This person is called a Floor Broker. Now this person goes to the part of the Stock Exchange that is allotted to this particular stock. Here there are companies that specialize in this stock. This means that they will usually, if not) always, buy and sell from people at the normal price. The floor broker then buys your ten shares from one of these people, reports his trade through the hundreds of computers on the floor, then reports to his colleagues back at the brokerage house that he bought the stock. The broker keeps a record that you own that stock, rather than sending you the actual paper stock certificates. If you ever want to sell them, your broker will sell them, deduct his commission, and then give you the money. Got all that? Well if you didn t, here it is again using a simplified example. When you want a stock, you call a broker. The broker calls a person on the floor (usually an employee of the broker). This person runs to the space that is allotted to this stock. He then buys the amount of stock from the specialists, or companies, that are there to sell and buy on a regular basis. He then tells the firm he bought it, and then you have your stock. RULES We have now learned how to hand over money to people, in exchange for stocks, but what is to stop them from cheating you, or from running off to Mexico with your hard earned 250 dollars that was supposed to go to McDonalds? Well to keep brokers honest, the government has put into place many commissions, and organizations. Of these organizations the major player is the Securities Exchange Commission (SEC). The SEC is a government agency whose purpose is to regulate the securities industry (the stock markets). It was created after the Great Depression when Congress passed the Securities Exchange Act of This agency decides what is legal, and prosecutes those who break the rules, along with setting many standards for brokers and investors alike. All companies traded on the many stock exchanges across America have to be registered with the SEC. Each must follow rules about what they can do with their stock, how they can advertise, and much more. Most of the rules placed on companies are to prevent the owners and employees from using insider information. Insider information is information that a person obtains about a company that is not available to the rest of the public that can be used to their advantage while buying stocks. For example, let s say you are the CEO of company XYZ, and company ABC is now in negotiations with you to merge, and create a much larger company called GE Il Inc. Now, usually mergers cause stock prices to go up, so if you, knowing that a merger is going to take place, go out and buy a lot of stock from both company ABC, and XYZ, you are using insider information, and are breaking the law. SEC rules and regulations not only pertain to companies on the Exchange, but to the brokers that trade, and to you, the investor. As an investor, you too, cannot buy stocks knowing information about a company that know one else knows. Brokers get the heaviest burden of rules and regulations from the SEC. Most of these rules are to protect you, the investor. An example of one of these rules is that when a floor broker goes to buy a stock on your behalf, he must buy from the lowest priced bidder, and when he is selling, he must sell it to the highest price bidder. Sounds like common sense, but in fact it is not. Floor brokers, could easily sell your stock really low to another broker, in exchange for them selling you a different stock really cheap, to give a better customer a better price. This would not be fair to you, being sacrificed to give another person a better price. Document2 Page #2

3 Document2 Page #3 MARKET TRENDS Why does the stock market go up and down? Theses fluctuations occur partly because companies make money, or lose money, but it is much more involved than that. A stock is only worth what someone will pay for it. Usually, if a company makes a lot of money, its value rises, because people are willing to pay more for a company s stock if the company is doing well. There are many other factors that affect the value of stocks. One example is interest rates, or the amount of money you have to pay a bank to loan money, or how much it has to pay you to keep your money in their bank. If interest rates are high, stock prices generally go down, because if people can make a decent amount of money, by keeping their money in banks, or buying bonds, they feel like they should not take the risk in the stock market. Many other factors have an effect on the stock market fur example, the state of the economy. If there is more money floating around, there is more flowing into companies making their prices rise. Yet another factor is time of year, and publicity. Many stocks are seasonal, meaning they do well during certain parts of the year, and worse during others. An example is an ice company, the ones that package ice that you buy at the supermarket. During the summer, with picnics, and sweltering heat, their product sells well, and thus their stock price goes up; But during the winter, when people are not as interested in a picnic with 20 below temperatures, their price goes down. Publicity has an effect on stock prices. If an article comes out saying that company ABC, has just invented this new type of ice that will revolutionize the industry, odds are their price will increase. Conversely, if an article comes out saying that company ABC s president is a crook, and stole the pension funds, it is a good bet that the price will go down. PICKING A STOCK WHAT IS A STOCK A stock is a certificate that shows that you own a small fraction of a corporation. When you buy a stock, you are paying for a small percentage of everything that that company owns, buildings, chairs, computers, etc. When you own a stock, you are referred to as a shareholder or a stockholder. In essence, a stock is a representation of the amount of a company that you own. The benefit of owning stock in a corporation is that whenever the corporation profits, you profit as well. For example, if you buy stock in Coca Cola, and they come out with a new drink that everyone buys in massive quantities, then the company will profit tremendously, and so will you. A stock also gives you the right to make decisions that may influence the company. Each stock you own has a little bit of voting power, so the more stocks you own, the more decision making power you have. In order to vote, you must either attend a corporate meeting or you fill out a proxy ballot. A proxy ballot is a substitute for your absence at the corporate meeting. A ballot is a series of proposals that you may either vote for or against. Common questions are who should be on the board of directors, and whether or not to issue additional stock. You can profit more by making smart decisions, such as voting for a smarter board of directors. Also, if you think that issuing additional stock may increase the value of the stock, then you would vote for issuing additional stock. There are four levels of stock you can purchase. The lowest levels of stock are the penny stocks. Penny stocks are small companies that have almost no chance of making it big, and they are usually of no value. These stocks could be a local chain of stores, or a company that does not provide anything desirable. Moving up one level, there are the growth stocks. Growth stocks are new companies that have a lot of potential for success, but they are not stable, and do not always become successful. These growth stocks are not always a safe investment, since they are not well established. Secondary issues are wellestablished businesses that are almost totally insured to continue growing in strength. They are a good investment, since the profit can increase a lot, but finding the companies can be hard. The highest levels of stocks you can buy are blue chip stocks. The older companies usually are blue chip, such as

4 International Business Machines (IBM) and AT&T, and Coca Cola. These blue chip stocks are the safest investment you can make, but they also take a lot more time to profit with. If you want to profit from buying a stock, you must decide on a successful company to invest your money in. There are many factors about the company you have to base your decision on. By analyzing all of the aspects, you have a better chance of predicting whether or not the stock will rise in value. A question to keep in mind is how much profit has the company made recently? If the company has not recently made a lot of profit, chances are it may never profit, and it is not a good idea to invest in it. If the company has made a lot of profit recently, then it may be a good investment, since the profit may continue to rise. Is the product or service provided popular and in demand? If the company offers an undesirable product, then the company may fail,, since no one will buy from them. If the company dies, then you suffer massive losses, so you do not want to invest in companies with an undesirable product or service. You want to invest in a company with a service or product that is in high demand. If a company invents a new kind of food that is incredible, and everyone wants tons of it, then you can profit greatly, since the company will make tons of profit. Is there a lot of close competition? If the company is the only company that offers something, then everyone has to buy from that company, meaning the company will grow larger, and profit a lot. For example, if there was a company called Sneakies and it was the only company to offer sneakers, then everyone would be forced to buy from them, and that would result in huge profits for Sneakies. In real life, though, there are big time competitors, such as Nike and Reebok. Therefore, Sneakies would not make a whole lot of profit, and neither would you. Stock analysts regularly get the answers to these questions, and many others, and make predictions about the stocks value in the future. Document2 Page #4 BUYING AND SELLING The first step when buying stocks is to decide what company to buy stock in. You can buy stock in any publicly held corporation, which means that the public can control the corporation. You cannot buy stock in a privately held or closely held corporation, which are corporations that are controlled either by a small group of individuals or by close friends and family. Fortunately, most of the larger companies are publicly held, and you can buy from them. When selecting a company to invest in, you should make sure they are in a strong industry, and make sure the company is strong or growing. For example, Coca Cola Enterprises is a large company that is one of the strongest in the soft drinks industry. This would make it a good stock to invest in, although finding a newer company that is growing rapidly might get you more profits quicker. Choosing the company to invest in is no easy job, and there are many different methods people have come up with to select one. Fundamental analysis is one method, in which you study the company s current management and position in the market. Technical analysis is another method which is totally based on charts, in which you identify trends the company has, and invest accordingly. One popular method is just throwing darts at the stock page, which often beats out all the other methods. After you decide what company to invest in, you need to find a broker. A broker is the only person that can make an order to buy or sell stocks. There are two types of brokers that every brokerage firm has. The first type of broker is a stockbroker, who researches investments, helps make goals, and give advice on investing. Discount brokers on the other hand, do not offer advice, and they do no research. They just are middle men in the transactions. When you give a stockbroker your order, they relay the order to the floor brokers. The floor brokers do all the actual buying and selling, and they hold a seat on the exchange. After you find a broker and buy the stocks, the broker does the rest of the work. You just have to call him up and place an order with him. The most basic order is the market order, where you just ask the broker to buy or sell your stocks at the best price he can get his hands on. Another type of order which takes more research and predicting on your part is a limit order. In a limit order, you tell the broker to

5 trade only when the stock is at a certain price or better. A stop order is an order which can save you from extreme loss. In a stop order, you tell the broker to sell your shares if the stock drops too low, and you tell him the price not to let it drop below. TRACKING To track how your stocks are doing, you have to look at stock listings. Stock listings are published in just about every newspaper. The listings look confusing at first, since they look like a mixture of numbers, but can be a very useful tool when tracking your stock s progress. The listings are organized into many columns, including the following information: 52 weeks high and low, company name, symbol, dividend, percent yield, PE ratio, volume, high, low, close and net change. 52 week high and low This field is a good indicator about a stock s volatility. Volatility is an indicator of the riskiness and potential for profit that the stock has. The greater the difference between the high and low, the riskier the stock is for loss and gain. If the difference between the high and low is small, then there is little potential for either loss or gain. Company name This field is usually abbreviated in the listings, and listed alphabetically Symbol This field is a one to four character symbol used as a sort of nickname for the company. Dividend This field is listed in dollar format, and it is the cash amount of money that the company will pay you each year for each stock. Percent yield This field is calculated by dividing the dividend by the closing price. It just tells you how much of the price of the stock you will be paid in dividends each year. PE ratio The price earnings ratio calculates the relationship between the price of a company s stock, and the annual earnings of a company. It is calculated by dividing the closing price of the stock by the earnings per share of each stock. Volume The volume is the amount of stocks that were traded the day before. This number is given in hundreds, so to get the actual number of stocks traded, multiply the number in that field by one hundred. If a small z is before the number, then the volume is not given in hundreds, and is the actual number of stocks traded. High, low and close These are the highest and lowest prices of the stock the day before, and the closing price for the day before. This is an indicator of how much the price of the stock fluctuated throughout the previous day. Net change This is the change of the price of the stock from the previous day. This gives you an idea whether the price is dropping or rising. In addition to the stock listings, stock price charts can sometimes offer a better view of how the stock is doing. The price charts graphically organize the value of the stock over time. The charts can give you information on the company s historical performance, the stock s stability or volatility, the stock s current price relative to the past, and the stock s growth rate. STOCK TRICKS There are several tricks that experienced investors use to make a profit. Like the rest of the stock market, these tricks are very risky, and you should know what you are doing if you use these tricks. The tricks include selling short, buying on margin, and buying warrants. The first risky trick is selling short. Basically, selling short is selling a stock before you actually buy it. To sell short, you first borrow stocks from a broker. Then, you sell them immediately on the market. You keep the money that you earned from selling the stocks, and wait, hoping that the price for the stock will Document2 Page #5

6 drop. If the price for the stock does drop, then you can buy back the stock, and give them back to your broker. You will then have made a profit, since you sold them for more than you bought them for. For example, if you borrow 100 stocks at 4 dollars per stock, and sell them in the market, you have 400 dollars. If you wait a while, and the price of the stock decreases to 2 dollars per stock, you can buy 100 stocks for 200 dollars. You then return the 100 stocks to the broker, pay a little bit of interest, and keep the other 200 dollars. Unfortunately, selling short does not always end as well as that. Consider if you borrow 100 stocks at 4 dollars a stock again. You then sell them and get 400 dollars. You wait a few weeks, but the price of the stock continues to increase. Before you know it, the price of the stock is 6 dollars. You have to give the broker his stocks, and you have to pay him interest. This means that you have to pay 600 dollars to get the stocks back, and right there, you just lost 200 dollars. Buying on margin is another trick which is basically buying stocks on borrowed money. You must first set up a margin account, which has a minimum balance of 2,000 dollars. Once you have a margin account, you can borrow up to 50 percent of the cost of buying the stocks you want. By borrowing 50 percent of the cost, you are controlling something twice as valuable as what you paid for. This will enable you to gain more profits with less money. For example, if you put in 500 dollars, and the broker lends you 500 dollars, then you have 1000 dollars to work with. You then buy 100 stocks at 10 dollars a stock. If the price for the stock increases to 15 dollars, and you sell at that price, then you have 1500 dollars. You then pay back the broker the 500 dollars plus interest, and you have made roughly 1000 dollars, doubling your initial investment of 500 dollars,. If you had only invested 500 dollars of your own money, you would have only gotten 50 stocks. Then, alter selling them for 15 dollars, you would have made only 750 dollars, which is only 250 dollars more than your initial investment. The risky part about this is that your losses are also magnified. Had you bought 100 stocks on margin at 10 dollars, and the price had dropped to 5 dollars, you would have lost all 500 of your dollars, since you have to pay the broker back his 500 dollars. If you had invested only your 500 dollars and bought 50 stocks at 10 dollars, and the price dropped to 5 dollars, then you would only have lost 250 dollars. Buying warrants is a less risky trick. A warrant is sold by a company that is planning on issuing stocks soon. The warrant gives you the right to buy stocks at a certain price. For example, if you buy a warrant to buy a stock at 5 dollars for I dollar, and the stock ends up being issued at 10 dollars a share, then you can sell the shares for a profit of 4 dollars per share, since you paid only 6 dollars total, and sold them at 10 dollars. Document2 Page #6