Introduction to Stock Trading
Wouldn’t you love to own part of a successful business without having to take the pressure that comes from the day to day management of the business?
Stock trading makes this a reality for many people.
By owning stocks in a given company, you can sit back relax and watch your company grow from one level to another.
Stocks are excellent financial instruments that allow you to grow your income by doing nothing but collecting dividends at the end of a financial year.
Investing in stocks is an integral part of any investment portfolio.
It is, therefore, important for you to have a solid understanding of stocks and how to trade them before embarking on your journey to financial freedom.
Stocks are traded in stock markets. It is, therefore, important for you to understand the stock market too.
The number of people trading in stocks has increased considerably over the past few years.
This has coincided with the advancement in technology that makes stock trading much easy.
Why you should Invest in the Stock Trading?
There several reasons why it is important that you start considering investing in stock trading.
The following are some of these reasons.
It has Higher Returns
Stock trading offer higher returns than many other kinds of investments.
Research shows that historically stock markets outperform savings and other safer investments options in many countries.
The stock market may not guarantee returns over a short period of time, but if you invest for longer, then you can be sure of ripping more than other kinds of investments.
You enjoy the leverage of a group investment
When you buy stocks, you get the right to lay claim to a share of a given company.
Since you are many decision-making becomes easier and you can actually earn without making any decision.
For a few dollars, you can buy a stock in a company with the best management team in the world where you will be guaranteed a share of the profits in terms of dividends.
You do not need large capital to start stock trading
Stocks are sold for a very small amount of money and you can actually start small with just a few hundred dollars.
You can then reinvest your earnings and watch your portfolio grow.
You can also buy cheap and sell when the prices are high and thus multiplying your investments.
It requires minimal Time to Trade
Unlike many other kinds of businesses, trading in stock requires a small amount of time.
This may allow you a lot of time to do other things that you love.
You can also trade effectively while having another day job.
This is because all you need to trade is a computer with internet or a trusted stock broker.
Stocks allow for Quick Liquidation
Unlike many other forms of investments, you can actually turn your stocks into cash very easily and quickly.
To liquidate you stock all you have to do is sell them in a stock market and this may take just a few minutes.
What are stocks?
You can increase your ownership stake in a company by buying more stocks.
Stocks are first sold by the original owners of a given company to get additional funds to be used in supporting the growth of the company.
This is usually referred to as the Initial Public Offer (IPO).
After the IPO, the issued stocks are then traded in the stock market.
Once you buy stocks of a given company, you become a shareholder.
This means that you now have a claim on everything the company owns.
This means that you together with other share holders owns the company and have the powers to make important decisions about the operations of the company.
This does not mean that you have to take part in the day to day operations of the company.
Instead, you have voting rights to elect the board of directors which handles the management of the company.
After you buy shares, you are then presented with the stock certificates.
This is the true representation of the stocks; it is a show of your ownership of the said stocks.
Today technology has made it possible to keep these certificates in electronic forms.
This simply means instead or receiving your stock certificates; they are sent to your brokerage that holds them electronically for you.
This makes it easier to trade by eliminating a lot of paperwork that may be required in the process.
Trading is now done by a click of the button on your computer.
The prices for stocks are determined by the expectations of the company’s earnings and profits.
This means that if traders believe that the company’s profits will be high they trade at high prices.
If the company’s incomes are dropping then, the prices for its shares also falls.
You can earn by buying stocks when the price is down and selling them when the price goes up.
If you bought stocks of a given company and then it performs poorly in the stock market and the value of shares goes down, you make a loss.
You can also profit from trading in stocks by receiving dividends.
These are rewards shareholders get from the company’s profits.
So if you invest in a profitable company, then you can earn dividends from the profits the company makes.
You invest and it is the duty of the management of the company to increase the value of your investments.
If this fails to happen, you have the power as shareholders of the given company you invested in to vote out the current management and bring in a new group of managers.
This may not always be possible especially in some instances where larger institutions own a large amount of shares in the company.
Usually voting is done by one vote per share, which means that people or organizations that own the most shares has the most influence in the management of the company.
Having little influence in the management of the company you invest in should not be a problem to you.
This is because you already have a claim to the profits and assets.
This means that you can still earn from your investments without having to work.
The more stocks you have the high share of profits you will get.
In case of liquidation of the company, then you can lay claim on the assets.
Stocks also guarantee you limited liability on your investments.
This simply means that you are not personally liable to creditors of the company if the company goes under.
Thus, in case of bad business you losses are limited to your investment in a given company.
There are several types of derivatives in financial markets.
The most common type of stock derivatives is the stock options.
Stock options give stock traders an option of buying or selling stocks at an agreed price by a given date.
Stock options are of two types; call options and put options.
The call option is sometimes referred to as the right to buy.
This is because you buy stocks and sell only when the price goes up.
You profit by the price of the held stocks going up.
The put option, on the other hand, is the right to sell.
In this option, you buy stock at a future lower price and sell them at the agreed higher price.
You earn profits only if the price of the stock drops.
Another common type of stock derivatives is short selling.
This term is used to refer to the process where you borrow stocks from your brokerage and sell them at the current high price hoping that the price will drop tomorrow so that you can buy them back and return them to the broker.
Your profit is the difference in prices between the stocks.
Stock derivatives are very risk and you should avoid them if you want to steadily grow your investments.
Different Types of Stocks
There are two major types of stocks in the stock markets; the common and the preferred.
The Common Stock
Common stock as the name suggest are the common stock trade on the floor of stock markets.
They represent the stake that you own in any given company.
When you hold common stocks, you have voting rights in the company and can lay claim on both the company’s assets and profits.
However, in case of bankruptcy you don’t get paid until the all the other groups that lay claim on the company (preferred shareholders, creditors and bondholder) are paid.
This is a kind of hybrid stocks that share the properties of both bonds and common stocks.
If you hold preferred stock, then you earn a fixed amount of dividend and not depending on the profits like the common stockholders.
Although their prices raise and falls just like the common stocks, holding preferred stocks means that you have forfeited your voting rights.
Stocks may also be classified differently for the purpose of trading.
This is usually along the characteristics of companies issuing them.
Thus in addition to these two types of stores there are also many other types that depends on classification.
The following are some of the common types of shares by classification found in stock markets:
- Small cap stocks These are stocks with a market capitalization of at most $2 billion. They have the potential to grow quickly. They are also very risky.
- Mid cap stocks These are stocks with a market capitalization of between $2 billion and $10 billion.
- Large cap stocks These are stocks of market capitalization of at least $10 billion. They are less risky but have a slow growth.
- Growth stocks These are stocks issued by companies with high potential for growth. These high growth rates are often represented by an increase in the stock price of the company. Most of these companies may not pay little or no dividend as they reinvest the profits.
- Blue chip stocks These are stocks of some of the biggest companies in the country. The companies may not have high growth rate but are stable and have had years of solid management. The Blue chip stocks are considered by many as some of the safest stocks you can invest in.
Why do Companies Issue Stocks?
Companies issue stocks in order to raise additional funding for their business.
This is a much cheaper form of raising additional capital as compared to borrowing the money from banks.
Issuing stock is favoured by many companies because they do not have to pay back the borrowed monies and interests.
All that is required is to share the profits among the shareholders in terms of dividend per share.
If the company is successful as a shareholder, you can earn more than the face value of your shares.
This is because the dividends may be paid regularly over a long period of time.
The value of your shares may also increase considerably.
What is a Stock Market?
The stock market or sometimes referred to as equity market is where shares, bonds and other types of securities are traded.
Stock markets are vital organs of the free market economy.
This is because they provide a channel through which companies can raise additional capital without having to borrow from expensive lenders.
They also enable investors grow their investments without having to start a business.
As an investor, the stock market gives you the chance to take part in the financial growth of a given company that you invest in.
When such a company is profitable, you earn through dividends and selling your shares at a much higher price than the price you bought the shares at.
In the invent the company makes losses then you lose your investment as the stock price comes crumbling down.
Stock markets are usually made up of two sections: primary markets and secondary markets.
The primary markets handle the initial public offers for new companies while secondary markets take care of the day to day trading of shares after the IPO.
Both individuals and large institutions are allowed to participate in both the sections of the stock markets.
Each country has its own stock market although some countries have more than one stock market.
The largest stock markets in the U.S are the Nasdaq and the New York Stock Exchange.
The New York Stock Exchange
This is the world’s largest and most prestigious stock market.
It was established in 1792 by the Buttonwood agreement.
It is the stock market of choice for most of America’s largest companies and the leading multinationals in the world.
The NYSE is a listed exchange where face to face trading takes place on the trading floor.
Orders from brokers are handled by floor specialists who match buyers with sellers.
The price of shares is determined by the auction method.
Once a transaction has been sealed the details are relayed back to the brokers who contact the seller or the buyer they represent.
The Nasdaq is the second largest stock market in the United States.
It was established in 1971.
It is an over the counter (OTC) type of stock exchange.
The market has no central location and trading is done online.
The market also attracts some of the largest corporations in the world.
Some of the big names trading on the market are Dell, Oracle, Microsoft and Cisco among others.
Unlike NYSE, the Nasdaq allows stock brokers to act as market makers.
They match sellers and buyers either directly or through the market links or maintain an inventory of all the sales.
Other important stock markets in the world that you can consider include the American Stock Exchange (AMEX) which is owned by the NASDAQ, the London Stock Exchange, Paris Bourse, which are now part of Euronext and the Hong Kong Stock Exchange.
Basically, each country has its own set of stock markets and you don’t have to travel longer distances to trade on this world major stock markets.
Sometimes stocks are cross-listed and you can buy stocks of a multinational company of your interest on your local stock market.
Importance of Stock Market
Stock markets are central to the performance of the economy of a country and the world.
They are also important to individual investors like you. The following are some of the importance of the stock markets.
Help companies raise money
Stock market allows companies to raise additional capital for its project by issuing stocks.
This helps companies get huge amounts of money quickly for important projects that enable growth and increase in profitability.
Help increase liquidity of investment
Stock markets make it easy for you to sell quickly and easily your shares in any given company.
This is a more straightforward and fast process than liquidating many other types of investments.
Many companies when seeking to increase their liquidity actively trade in their own stocks.
Stock markets are significant indicators of the performance of a country’s economy
Stock markets are important in wealth creation
Majority or rich people in the world have made a future trading in stock markets.
Trading in stock markets can help increase and multiply your personal wealth.
This is one of the main reason why many people invest in stock markets.
How does stock market work?
Stocks are traded on stock markets.
This is the place where buyers and sellers meet to exchange various kinds of securities.
Some stock exchanges like the New York Stock Exchange have physical locations known as trading floors where selling and buying of stocks take place while other such as Nasdaq are virtual and trading is done online.
The stock markets play the important role of linking buyers and sellers of various types of securities.
This makes investing in companies much easier and quicker.
Typical a stock market works by having potential buyers place bids of particular prices on given stocks and potential sellers ask for specific prices for the given stock.
If the buyers accept the asked price, the stock is sold and the deal done.
Alternatively the seller may accept the bid price for the stock to be sold.
A sale takes place only when the bid and the ask prices are the same.
This is usually on the first come first served basis especially in cases where multiple buyers places bids or multiple sellers give their ask price.
How to start Trading in Stocks
There are a number of ways you can invest indirectly in the stock market.
These include mutual funds and other kinds of financial investment plans.
However, if you want to invest directly in stocks, there are only two ways you can use; a traditional stockbroker and an online broker.
1. Using a Traditional Stockbroker
Traditional stock brokers are licensed specialists who will help you with your investments.
They give advice and also help you place an order for buying or selling stock.
These specialists are referred to as traditional because they were the only way of buying stocks before technology changed things a little bit.
The advantage of using a traditional stock broker is that you will have access to advice tailored to your specific investment goals.
A good stock broker will take into consideration your financial goals and needs, you investment timeline and your risk tolerance when providing investment advice.
The stock broker can also be made the manager of your portfolio.
2. Using an Online Stockbroker
An online stock broker is a special software that enables you to be your own stockbroker.
It gives you a direct access to the stock market and thus allowing you to sell or buy stock online.
You pay a much lower commission when using online stockbroker than you pay for a traditional stock broker.
This is because the online stockbroker is a do it yourself system.
However, you have to read a lot of reports and pieces of advice in order to make the right decision.
This is because you are your own advisor and to make an informed decision you have to do some research.
How to pick a Stockbroker
You must consider a number of factors before settling on a stock broker. These factors are:
1. Broker’s Fees
Stock brokers earn a commission from every transaction you make.
Thus, you should ensure that you get the most affordable broker if you want value for your money.
If you pick an expensive broker, you will pay more in terms of commission, tax and transaction fee.
These may eat into your earnings from the stock market
2. Reputation, Stability and Trust
It is important to settle for a reputable stock broker.
This will guarantee you high-quality advice that might result in high rate of success.
The broker must also be stable and trustworthy untrustworthy stock brokers may close shop with your investment or give you poor quality advice.
3. Market advice given
The kind of professional advice provided should correlate with the commission charged.
Any stock broker who cannot justify their commission rate should be avoided.
The stock broker you pick should meet all your investment needs both in terms of professionalism and cost.
If you have a small capital, then it is important to settle on a stock broker charging the lowest fee.
This will ensure that you put a higher amount of money in stocks and not transaction fees.
Buying Stocks in Primary Markets
There are two ways you can buy stock in the primary markets.
These are Initial Public Offers and Further Public Offers.
Initial Public Offering (IPO)
An unlisted company that wants to raise more money to fund its expansion, diversification or working capital requirements may issue an IPO.
An IPO is the first step towards the listing of any company.
The money raised from the IPO does not go to the individual owners of the company but is used for a specified purpose.
Stocks in an IPO are sold at a specific price set by the company and not by auction method as is the case in the secondary market.
Further Public Offering (FPO)
A further public offer happens when a listed company makes an offer to issue new shares to the public.
The reason for a further public offer may be similar to those for IPOs because as companies expand they may need more capital to sustain their expanded operations.
A given company can also opt for a rights issues where existing shareholders are offered new stocks.
However, most companies prefer an FPO as it has the capacity to raise more money that a rights issues.
The pricing for shares offered in IPO or an FPO is not determined by the biding method as other shares.
The company sets the price based on an analysis of its market performance.
The company has then to give a full disclosure of the price and justify it using sound economic parameters.
Stock trading in Secondary Markets
A secondary market refers to where the shares bought during the IPO and FPO in the primary market are later sold.
In a secondary market, shares are bought by bidding through stock brokers.
Before buying shares of any given company, it is important for you to investigate the given company and so that you buy shares from a stable company.
You can get valuable information from the stock exchange websites, from your broker or from the company of interest.
As a new investor, it is important to be cautious so that you do not lose a lot of money and get demoralized.
What causes Prices to Change?
The stock prices keep changing as a result of what is known as market forces.
The share prices are determined by the supply-demand mechanism.
If more people are interested in buying a particular stock as compared to those selling, then the price goes up on the other hand if more people are selling as opposed to those buying then the price drops.
This demand and supply are determined by a number of factors in the market.
The major determinant of demand for a particular stock is the performance news about the company.
If accompany is profitable in a particular year and there is a projection for further profitability in the coming years then its shares are likely to be in the demand.
On the other hand, a company with declining profitability is likely to attract fewer people and may end up with dropping share prices.
STOCK TRADING TERMS
Basic Stock Terms
There are numerous terms used in the stock market every day.
To be successful in stock trading, you must learn some of the basic terms used in stock exchange.
This is important in helping you get a grasp of what is going.
It is also advisable that you should keep learning and expanding your vocabulary as you develop your knowledge of the stock market.
The following as some of the major basic terms to get you started.
This is the lowest price a seller of stocks is willing to accept.
The total amount the seller of stock is willing to accept for the sale of a given stock.
This is the average price of stocks an investor buys as the price is going down.
This refers to the market when the prices are going down
This is the ratio of prices of stock to the movement of the whole market. For example, if stock D is given a beta of 1.8 then it means that for each 1.8 points move in stock D the market moves 1 point.
This is the highest price a buyer offers to buy a given stock.
Blue Chip Stocks:
These are stocks of the largest and most stable companies in the market.
This is the not worth of a given company as depicted from its balance sheet
This is a prolonged gap as share price keeps moving in the direction of the gap.
This refers to a period in the stock market when prices are going up. It is the opposite of the bear market.
This is a specialist who buys and sells stock for investors for a fee (commission)
Buying Into Weakness:
This refers to the action of buying shares as they drop in price instead of waiting until they reach the lowest price.
A stock market when the prices keep moving rapidly in all directions without following any real trend
This is the fee that the broker is paid for buying or selling shares on your behalf.
This is the term that is used to refer to the dividend a buyer gets from buying a kind of share that lets the buyer receive the following dividend
This is an order that is only valid for a given day and is canceled if not filled by the end of the day.
This refers to all the activities involved in the buying and selling of stocks on the same day
This is the earnings paid to shareholders as part of the company’s profits. It may be paid annually or quarterly depending on the profitability of the company.
This is the term used to refer to either common or preferred stocks of a given company.
An exchange is another term for a stock market. It is where stocks are traded.
Refers to the when an order to sell or buy shares has been completed successfully.
This is the term used to refer to the act of limiting your losses by taking offsetting positions
This abbreviation stands for High of Day and is used to refer to the highest price that stocks trade for a given day.
This is the reference point used by traders and portfolio managers when trading shares
This refers to trading based on inside information of a given company
This is a sector of the stock market that is underperforming.
This refers to a sector of the stock market that outperforms the market.
This is an order to sell or buy a given stock at a fixed price.
This is the abbreviation that stands for the Low of Day and is used to refer to the lowest price at which stocks were traded during the given day.
An investor (you) may take a loan from (your) broker to invest in the share market. The margin is the difference between the loan borrowed and the price of stocks bought
This is an account held by an investor and uses credit from a broker to buy shares. An interest is usually charged on the credit which is only given after depositing the margin
This is the total value of a given listed company and is arrived at by multiplying the current stock price with the total number of shares issued by the company.
This is a brokerage that successfully connects a buyer and a seller and seals the deal.
This is the average price per share of stocks within a given period of time
This is the difference between yesterday’s closing price and today’s last traded price.
This term is used to refer to person appointed to act on behalf of another in the stock market
An order is your bid to buy or sell a specific amount of shares for a specified price
This is a term used to refer to a situation when the price of a stock is too high
A term used to refer to a situation when the price of a stock is too low
This is a collection of different investments owned by an individual.
Proxy is a term used to refer to an individual that is appointed to vote on the behalf of another person during the shareholders meeting
This is the stock’s latest trading price on the stock market
This is a rapid increase in the prices of a given stock
This is a collection of stocks within the same field or business for example agriculture, technology or manufacturing
The spread is the difference between the ask and the bid price.
It refers to the movements in the stock prices with volatile stock being those with the frequent unsteady changes in prices.
Volume is used to refer to the cumulative number of stocks traded during a given period of time
It is the measure of earnings from an investment paid as dividends