As a doper who’s just starting to get into the stock market, I’m hoping someone out there can provide a little crash course in playing stocks. Particularly on how the market itself works, such as:
What controls whether a stock goes up or down? I’m pretty sure that it’s more than a simple supply-demand relationship.
When I buy or sell stock, am I doing so into a general pool of stock or do I have to wait until someone wants to sell (or buy) the quantity of stock that I want to buy (or sell)?
When looking at stocks to buy, is P/E ratio a good indicator? If so, what is a good ratio to look for?
Any and all other information, tips, advice, etc would be greatly welcomed…
Ah, but that’s exactly what it is! The value of a stock is essentially the value of all its future potential income. If people think the future potential income is a lot, then the demand for the shares (which are finite in number) goes up.
Generally, you (or more commonly, your broker) sell the shares to a person working for the market itself (called a specialist) who then finds people willing to buy. Shares that are not publically traded are sold “over the counter” and directly from buyer to seller.
P/E ration is definately an important thing to look at, but there are dozens of other factors to examine also. I reccomend reading The Motley Fool for tons of good advice.
What controls whether a stock goes up or down? Supply, demand, fear, and denial. Supply and fear drive it down, demand and denial drive it up.
When you buy stock, you’re buying it on the market – i.e., from someone. You don’t generally need to wait for someone who wants to sell some, but you DO need to wait for someone who wants to sell some at a price you’re prepared to pay. Similarly, when you sell stock, you’re selling it on the market – i.e., TO someone. You don’t generally need to wait for someone who wants to buy it, but you DO need to wait for someone who wants to buy some at your price.
P/E ratio is certainly a popular indicator; I’m not sure there ARE any good ones.
I think purchasing individual stocks is a terrible idea because you are exposing yourself to lots of unsystematic risk. Since unsystematic risk can be eliminated through diversification (cheaply, too—many index funds have expense ratios of about 0.25% or less), the expected reward for taking this risk is zero, according to the Capital Asset Pricing Model.
Eugene Fama and Kenneth French’s analysis of past returns of the stocks traded on the NYSE from 1929 to 1997 showed that the bulk of returns of diversified portfolios of stocks could be explained by just two factors—size (market capitalization) and book to market (book value divided by market capitalization). Small company stocks had higher returns than large company stocks, and high BtM stocks had significantly higher returns than low BtM stocks. These excess returns likely existed only because these companies carried higher risks and, in the case of the small caps, reduced liquidity.
There are some people who think that you can predict where a stock price is going to go based on the pattern it has exhibited in the past. This is called technical analysis.
There are some people who think that you can look at a company’s financial record and predict what future growth and dividends look like, and discount those to get a present value which is the price that the stock will tend to. This is called fundamental analysis.
There are those who say that say that if you could identify a profit opportunity based on past performance, then everybody would jump on the bandwagon and the profit opportunity would dissapear before you really get the chance to take advantage of it. They also say that there is so much guess work in predicting future growth and dividends, that the resulting estimate of stock value is essentially meaningless.
People in the first two groups will tell you to look into brokers and/or mutual funds who subscribe to their preferred method of analysis. People in the third group will tell you that you can’t beat the market, so your best bet is to buy a broad based market index fund pegged to the S&P 500 or the Wilshire 5,000.
I’m in the third group. Personally, I think the smartest thing you can do before getting involved in the market is to take a couple weeks to read the following books: A Random Walk Down Wallstreet and A Mathematician Plays the Stock Market. The first book covers the failures of technical & fundamental analysis, as well as giving details on what sort of things you want to get into to ride the market itself rather than some expert’s picks (guesses?). The second book, written by Paulos, a mathematician and mathematics popularizer, uses the author’s personal account of losing his shirt in Worldcom by falling for every just about every mistake that a person can fall for. (He also gives the efficient market paradox: the market is efficient because people think they can beat it.)
Answers above are good, I would just like to add a non-factual answer in the form of a caveat. Your question about “playing stocks” is like a guy about to walk into a casino for the first time asking about “playing poker.” Your questions are very good ones but so fundamental that it sounds like you would be eaten alive were you to jump into the market. The stock market, as has been mentioned above, is very complex. There are tons of day traders out there, many or even most of whom lose money, even the ones that are smart. Anecdotes include one guy who lost his savings that had been earmarked for med school (sorry, no cite, but it was a story by a major news publication).
Also please note the difference between “playing stocks” and “investing.” “Investing” means you are conscientiously becoming part owner of a company that you think will provide good value in the long run. “Playing stocks” is more like playing poker–you’re trying to make gains by short-term turnarounds, by being smarter or more prescient than the majority of people in the market. Yeah, you can make a quick buck at it, but you probably won’t.
Although commodities are much different than stocks, I’ve always remembered what my econ prof said. He knew a guy that got a bachelor’s in business, an MBA where he specialized in study of the cocoa market, and then got a Ph.D. where he did his thesis on the cocoa market. Then he went to work for Nestle. After he had been there for five years, thenhe started investing in cocoa futures. That’s the kind of guy you’re trying to beat.