I have always been fascinated with the stock market, but have no knowledge or understanding. I would love it if someone patient would take the time to help explain it to me.
You are some of the smartest people I know, and while not all of you are patient, I am hoping you will try hard, math was never my strong point.
Any volunteers?
Well, I’m not sure math has all that much to do with it. I guess it depends on how much you already know. Basically you can buy or sell shares of stock. Owning a companies stock means you own a part of that company. The share prices rise if the company is doing good and falls if the company doesn’t meet expectations.
Of course other things can influence share prices, and theres a hell of a lot more to it, but that covers the nuts and bolts of it.
So if I wanted to buy stock, how do I do it? Can you buy with little money, or do you generally need a certain amount first?
There are a couple of ways to buy stock, the most common way for the lay person to purchase stock is by using online brokers. While I personally don’t endorse any one in particular bankrate.com reviews a bunch of them every year. Heres the link for you
Technically you could invest with $100 but the commisions and fees for such a small account would probably eat a chunk of your buying power.
Stocks for nubes:
The process begins when companies “go public” to get money for them to grow. They issue “shares” of the company which are supposed to be like part ownership in the company. At the IPO (Initial Public Offering), people and companies by up all the shares that the company is offering based on an IPO price that the company has asked for. This may be adjusted if the price is too low or too high based on initial estimates.
The company gets all this money that it asked for to grow the business.
All these “shares” with the company name are now floating around in public but the company already got its money for them and it is largley out of the game after this point.
People trade these “shares” with the company name on them like they would collectibles. You can buy a Microsoft share through a complicated process from a guy named Bob in Omaha but that only affects Microsoft indirectly. Bob gets the money and you hope to later pawn that same share on another Bob for a higher price later. In this way, it is like a pyramid scheme.
The market for a particular stock “reacts” to news about the company but these ways are not very predictable. Good earnings estimates from the comapny usually mean that the stock will go up but it is unpredictable how much that will be. Stocks aren’t tied back to the company in any absolute mathematical way. The laws of the psychology of economics tend to be more important.
Company success does have an influence on stock prices when you get to the extreme ends. A completly bankrupt company will have worthless stock. You want to dump stocks before they get to that point.
Some stocks do have inherent value but that is becoming more rare. Some stocks issue “dividends” which are basically a share of the profits for that little slice of the company. Not all profits are paid out because that means the business can’t grow. Companies that pay dividends have stcok that is easier to calculate a return on investment and that stock is more directly ties back to the original company because buyers have a rough estimate of at least part of their expected return.
Stocks are traded on a number of exchages. The most famous are the NYSE (Most large traditional companies) and the NASDAQ (focused on hi-tech). These exchanges simply match up buyers with sellers in a dynamic way during trading hours. You can pay old style stock-brokers to submit a trade for you and give you advise or you can just submit a trade yourself over a service like E-Trade which sends the trade to the market at the current price or the price you are looking for. These exchanges are nothing more that ongoing auctions for thousands of different stocks and they al have people or systems in place to dynamically establish the price to match the current demand with the current supply.
This is all very basic economics with a lot os psychology thrown in. There is little pure math although the Holy Grail is a model of economic psychology that can predict stock prices. “Buy Low, Sell High” is the sum of the game. It is really just a form of gambling except the overall expectation is a positive return rather than a negative return like in casinos.
That link must be a few years old, some of the companies they rate no longer exist (including their “winner”, Datek, which has been subsumed by Ameritrade).
Any of the big on-line brokers are probably OK. You might also want to check your bank and/or credit union; some of them have investment partnerships now. Check specifically for the broker fee on a trade (somewhere in the $10-20 range is reasonable), and whether it’s higher for “limit” orders (it shouldn’t be more than $5 higher).
When you’re first starting out, you’ll mostly want to place limit orders (they “limit” the amount you’re willing to pay or sell shares for), since they cover a multitude of potential newbie mistakes.
Biggest advice, assuming you can afford it: Take a couple hundred dollars and just do it. Assume you’re paying the $200 as “lessons”, with the upside that you probably won’t lose the money (some will get eaten up in commissions). Trading isn’t that hard, but it’s scary to a lot of folks: every person I know who starts wishes they’d done it earlier.
It used to be that you generally had to buy/sell 100 shares at a time. In these days of computerized trading, you can buy/sell individual shares if you like. Remember that the trade commission is independent of number of shares, though:
Let’s say you want to by “FOOB” company (I made that up, if it exists, assume it doesn’t), currently trading at $10/share. If your broker charges a $15 commission, it will cost you $15 to buy the stock, and another $15 when you (eventually) sell it, for a total of $30 in commissions. Let’s say FOOB goes up to $12/share and you decide to sell:
So, if you buy 1 share, then it costs you $25 to buy ($10 for the share + $15 for the commission). When you sell it, you get -$3 ($12 for the share minus a $15 commission). Your stock market experience has cost you $28, which you can write off as a capital loss on your taxes.
On the other hand, let’s assume you buy a mere 10 shares. This costs you $115 ($10/share * 10 + $15 commission) when you buy. When you sell, you get $105 ($12/share * 10 = $120 - $15 commission). Now your loss is only $10.
If you buy 100 shares, it costs you $1015, but when you sell you get $1185, for a profit of $160. You pay taxes on that $160 either at your base rate, capital gains rate (usually lower) depending on how long you held the stock.
So you can see that with moderately moving stocks, it’s better to buy larger amounts. However, if you hold the stocks long enough for them to significantly gain in value, even small purchases can be profitable.
Disclaimer: This is not financial advice. I am not licensed to give you the financial advice I am not giving you here.