What is stock
HOW THE MARKET WORKS
What is stock?
Stock is a piece of ownership of a company. When a company needs to acquire extra money to help grow the business, they can sell some or all of the ownership of the company in the form of stocks. So if you were to buy 100% of a company's stock, you would own the whole company. If you own enough stock you also have some decision-making power within the company. Buying stock is a very popular form of investing.
What is a share?
A share is one individual piece of stock. It represents a very small percentage of ownership of a company.
What is the Dow Jones or the DJIA?
The Dow Jones Industrial Average (often referred to as the "Dow") is an averaged number representing the values of 30 U.S. "blue-chip" stocks. The DJIA is the most well-known market indicator in the world and was created in 1896 by Dow Jones & Company, which is actually a publicly-traded company (DJ) on the New York Stock Exchange (NYSE). They produce many important business publications including The Wall Street Journal, Barron's, and several stock indexes.
What is the Nasdaq?
The NASDAQ refers to two different things. First is the largest electronic stock market in the U.S. - the National Association of Securities Dealers Automated Quotation System. Second is the popular stock index called the NASDAQ Composite Index. It measures all domestic and international stocks listed on The NASDAQ, which number over 3,000. It was started in 1971 and is now one of the most important stock indexes.
What is the Big Board?
The Big Board is another name for the New York Stock Exchange.
What is the S&P 500?
The S&P 500 is a stock index published by Standard & Poor's. It measures 500 U.S. stocks that are supposed to be representative of the overall stock market. It was created in 1957.
What determines a stock's price?
There are many factors that play into a stock's price. Overall, though, the price is determined by investors' perceptions of what the stock is worth.
Some of the biggest factors include:
How big and successful the company is (especially its earnings)
Recent company news
The state of the U.S. and world economies
Whether there is a bull or bear market
World events, whether good or bad
For more information, see our Stock Prices page.
What is a bull market?
A bull market occurs when stock prices are rising faster than their historical averages. It can last months or even years. It is the opposite of a bear market.
What is a bear market?
A bear market occurs when stock prices are falling faster than their historical averages. It can last months or even years. It is the opposite of a bull market.
What is a market crash?
The market has "crashed" when stock prices have dropped dramatically. One of the worst crashes was Black Tuesday, which occurred on October 29, 1929 and led to the Great Depression.
What is insider trading?
Insider trading occurs (1) when an insider to a company, such as an officer or someone who owns a large percentage of the company, trades the company's stock. This is legal and acceptable, as long as that person is not trading based upon non-public company information.
Insider trading also occurs (2) when anyone, including employees, trades using non-public company information. This is considered illegal.
How much money do I need to get started?
These days, you can open an online account with a brokerage with as little as $5. When you purchase stocks, your brokerage will generally charge you a commission fee of $5-25, depending on the type of brokerage and type of order you place.
What is the Bid price? What is the Ask price?
When you request a quote for a stock, you will receive the bid price and the ask price. The bid price is the best (highest) price you might receive if you sell your stock back to the market. The ask price is the best (lowest) price you might receive if you buy stock from the market.
You are not guaranteed to get these prices because the market fluctuates constantly and prices change quickly. Also, if you buy (or sell) shares of a low-volume stock, you run the risk of affecting the price due to excess demand (or supply).
Will somebody always buy my stocks when I sell them?
No. If you try to sell more shares than people are willing to buy or if your price is unreasonable, it may take a long time for them to sell, if at all. However, if you use market orders on medium or high volume stocks you should not have any problems selling them immediately.
What is day trading?
Day trading is the process of buying and selling the same stock during one day. Professional day traders commonly trade many times per day. More Details.
When is the market open?
U.S. markets are usually open 9:30am-4:00pm Eastern time, except on holidays.
How much return can I expect?
Historically, the market has advanced roughly 10% per year. Of course this rate fluctuates constantly. For instance, it may grow up 30% one year, then fall 20% the next year.
How do I know which stocks to buy?
That is a great question. With over 8,000 different stocks to choose from, it can be overwhelming to pick some possible winners.
Many people simply buy stocks that are recommended to them by their brokerages, their friends, or experts from TV, magazines, and newspapers.
Some people buy stocks from companies they think are big, stable, and successful. This may seem like a safe route, but there are no guarantees.
Other people buy stocks based on rumors that the price will rise/fall sharply soon.
Many experienced traders watch financial news on TV, read the relevant newspaper stories, and investigate companies that are in the news. They also use "technical indicators," which are numbers or graphs which may help indicate whether a stock will rise, fall, or stay the same.
A few people will randomly pick stock symbols by throwing a dart at a newspaper, for instance.
What is a mutual fund?
A mutual fund is a fund created by an investment company which combines money from many investors and invests it in a group of stocks, bonds, or other investment vehicles. The investment company actively manages the portfolio to meet a desired goal, such as long-term growth or steady dividends. One major benefit is diversification. Many mutual funds also charge a fee when someone buys or sells shares.
When someone buys shares of a mutual fund, they are not directly buying shares of the underlying companies. Instead, they are entitled to a proportional amount of the fund's profits, which are usually distributed two or three times per year.
What is a mutual fund's N.A.V.?
The Net Asset Value (NAV) is the current price of a mutual fund, which is calculated at the end of each business day. It is the total value of the fund's assets minus its liabilities and divided by the total number of shares outstanding. It is similar to a stock's closing price for the day.
What is a 401(k) plan?
A 401(k) is a type of personal pension plan that is offered by many employers. Employees contribute part of their salary (before taxes) and employers commonly match part of the contribution. The bulk of the plan is usually invested in mutual funds.
What are the main ways to make money with stocks?
Buy Low, Sell High (traditional long trading)
Sell High, Buy Low (short selling)
Dividends
Options trading
Futures
What is short selling?
Short selling is the act of selling stock that you don't own at a high price by borrowing it from a brokerage and then buying it back at a lower price in the future. The hope is that the stock price will drop in value and a profit can be made. This is an advanced technique that has strict requirements and higher risks. More Details.
What is a dividend?
A dividend is money that a company gives to its shareholders when it has extra profit. Since the shareholders own the company, they deserve its profits. However, sometimes companies want to use these profits to help grow their business and decide not to distribute dividends, at least for a while.
What is the P.E. ratio?
The Price to Earnings ratio is simply the price of a company's stock divided by its Earnings Per Share. It is often used as an indicator of whether a stock is overpriced, underpriced, or on par. The PE ratio by itself is not always enough to make a good determination but it can be helpful to compare it with other companies in the same industry. The NASDAQ's average P/E is about 35.
What is a stock split and a reverse stock split?
A stock split is an increase in the number of outstanding shares of a stock. The price of the stock is immediately adjusted so that the total equity remains the same. For instance, if a $100/share stock splits 2 for 1, there will be twice as many shares but they only be worth $50 each now. This is usually done to make the stock more affordable to the public.
A reverse stock split is a decrease in the number of shares. This is usually done to raise the price per share to meet stock exchange requirements or simply to look more "healthy."
What is an IPO?
When a company issues stock to the general public for the first time, it is called an Initial Public Offering. The SEC has strict guidelines on how this is carried out. The company can issue more stock in the future, which is called a Secondary IPO.
What is Dollar Cost Averaging?
DCA is the act of buying the same dollar amount of a stock each month. This allows you to buy more shares when the stock's price is low and fewer shares when it is high. It can often be more successful than buying the same number of shares each month.
What is a penny stock?
Less than $1 (or $5 in some cases) per share. More Details.
What is a small-cap stock? Mid-cap? Large-cap?
These terms refer to a company's market capitalization, which is the number of outstanding shares times the stock's price.
|Small cap: |$250 Million to $2 Billion, approximately |
|Mid cap: |$2 Billion to $10 Billion, approximately |
|Large cap: |$10 Billion and up, approximately |
What is a Blue Chip stock?
It is the stock of a large company that has a long history of stable operation and solid stock performance. A great example is General Electric.
What is the SEC?
The Securities and Exchange Commission (SEC) is the government agency responsible for protecting investors by monitoring and regulating brokers, dealers, and the stock and bond markets in the U.S. They also make sure publicly-traded companies disclose the required business details to the public.
What is a Margin Account?
A margin account allows you to quickly and easily borrow money from your brokerage to purchase additional shares. In other words, it provides leverage for your account. It also allows you to do short selling. Of course interest is charged interest on any borrowed money and the SEC has very strict regulations on these accounts.
Stock market prices are affected by business fundamentals, company and world events, human psychology, and much more.
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Introduction
Stock market prices are affected by business fundamentals, company and world events, human psychology, and much more.
Stock trading is driven by psychology just as much as it is by business fundamentals, believe it or not. Fear and greed are the two of the strongest human emotions that affect the market. For example, it is easy to get caught in the trap of selling a stock prematurely because it dipped temporarily and fear set in. On the other hand, it is also easy to miss out on a respectable gain because greed was telling you to hold out for more, and then the stock drops back down.
One of the main business factors in determining a stock's price is a company’s earnings, including the current earnings and estimated future earnings. News from the company and other national and world events also plays a large role in the direction of the stock market. Some examples of this are oil prices, inflation, and terrorist attacks.
Every analyst and trader has a different perception of what that stock price should be now and where it might be in the future, and trading decisions are made accordingly.
Bad News or "Good" Bad News?
Layoffs
This is usually good for the company and its stock price because expenses will be reduced significantly and quickly. This should help increase earnings right away. It is not always a major warning sign; it could just be a reaction to a slower economy. It is one of the quickest ways a company can cut expenses if sales have not been meeting expectations.
Store Closings
This event often causes the stock price to go up for the same reasons as layoffs. However, this is not always the case. Closing stores actually requires a lot of money, and the positive effects of it do not take place immediately. This could be a sign that the company is truly in trouble at the moment. They probably have lower sales and higher expenses than they want, possibly due to a slowdown in the industry or the overall economy. The good news is that their management is being pro-active about maintaining profitability. Unfortunately, the stock price may go down for the next few months.
Firing of CEO or Company Official(s)
This may sound very negative at first, but it does show that the company’s board of directors was bold enough to take drastic actions to help the company in the long run. The stock price could go up or down after this announcement, depending on the situation. In some cases this event could be a sign of corruption that reaches beyond these individuals and there could be more negative announcements to come.
Market Scandals
Traders tend to frown upon corruption in the stock market. Mutual fund scandals that have occurred in the past few years and corporate corruption such as Enron are two such examples. If people cannot trust the stock market, why would they invest their hard-earned money in it? In these situations it is harder for the market to go up because there is a lower demand for stocks.
Analyst Recommendations
Many traders rely on experts' opinions about companies and future stock prices. Are they always correct? Of course not. Nobody can predict what will happen in the future. They can, however, make educated guesses based on past performances and future prospects for the companies and industries they follow.
Round Numbers
Traders often like nice round numbers for their perceived stock price, such as $10.00 or $35.00. It is common for prices to settle near these round numbers, at least briefly. Also, many traders place automatic buy or sell orders right near these round numbers, causing the stock price to become slightly erratic when it first reaches that target.
Technical Analysis
One of the most popular methods for helping predict a stock's price, at least in the short term, is called Technical Analysis. This method involves looking for patterns or indicators in stock prices, volumes, moving averages, and many others, over time. Obviously nobody can predict the future but this method can be effective in many cases because human beings are somewhat predictable. For example, when people see a stock start falling dramatically they often panic and sell their positions without investigating what caused the fall. This causes even more people to sell their shares and this often leads to an "overshoot" of the stock price. If you believe the price went too far down you can try to buy it at the bottom and hope that it will come back up to a more reasonable level.
Another common example involves Moving Averages. Many traders like to chart the 50-day and 200-day Moving Averages of their stock prices along with the prices themselves. When they see the current price cross over one of these Moving Averages on the charts it can be an indicator of a change in a long-term trend and it may be time to buy (or sell) the stock.
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