Stock Market Basics
Many people ask the question - what is the Stock Market anyway?
This Stock Market Basics page presents a general overview of the stock market.
Think of the Stock Market as a place where the prices of a company's stock are determined. Did you know that there are a number of different stock exchanges?
The two primary ones that will be helpful for you to know are the New York Stock Exchange (NYSE) and the Nasdaq stock market.
Remember I mentioned that the stock market is a "place"? This is because when stocks are traded, even though there are a number of different market procedures, there really only two types of "places" that you can trade in:
1. Physical location exchanges which includes the NYSE that I mentioned earlier, the American Stock Exchange (AMEX) - which was purchased in 2008 by NYSE, and other regional exchanges.
These exchanges are housed in a building, and actually allow a limited number of people to trade on their floor. The security exchanges facilitate the exchange of communication between buyers and sellers.
2. Electronic dealer-based markets or over-the-counter (OTC) markets which includes Nasdaq and other smaller dealer-based markets. Nasdaq is considered a less formal OTC market.
Let me explain OTC.
OTC is an auction market where buy and sell orders come in more or less at the same time.The goal of the exchange members is to match the orders received.
Dealers in this market trade over the telephone, fax or electronic network instead of a physical trading floor. There is no central exchange or meeting place for this market.
When companies are new or small, their stocks may be traded infrequently. So what some brokerage firms do is that they maintain an inventory of these stocks and actually act as a "market" for these stocks.
Am sure there is a lot more that can be said about the Stock Market - but on this Stock Market Basics page, I want to keep it to the basics.
When is the Stock Market Open?
The Stock Market has traditionally been open for business from 9:30 a.m. to 4:00 p.m. EST.
The advent of the Electronic Communications Networks (ECN) has now provided the ability for investors like you and me to conduct after hours trading, should we choose to.
Initially trading after-hours was limited to high net worth investors and institutional investors, but is now open to any investor willing to stomach the risk.
Why is the Stock Market Important?
The stock market is important for a number of reasons. Here are some of them.
1. It is a place for companies to raise money (capital)
2. It is an important part of the dynamics of economic activity
3. It influences increased business investments and vice versa
4. It is a place where investors like you and me can make money (buy low / sell high)
Ok. So we now have an idea as to what the stock market is.
Uhmmm..What is a stock?
A stock is share(s) you own in a company that has raised capital through the issue of shares. The shares you own entitle you to an ownership interest which is often called equity. This is why you often hear people say that "they owns X % shares in a company's stock"
To bring it home - when you buy 100 shares of Google it means that you own Google stock and you are therefore a stockholder with certain entitlements depending on the type of stock you own. Of course owning 100 shares of Google is like a drop in the ocean - there are over 317 million outstanding Google shares, and a company like Vanguard Group owns almost 8.5 million shares - which is only 3.5% of the total outstanding Google shares.
Stock Prices - how are they determined?
As part of the stock market basics, it is important to understand how stock prices are determined.
For example - How is Google stock, and stock prices for all the public traded companies determined?
Here is a definition that I like that should be helpful.
Stock prices are set by a combination of factors that no analyst can consistently understand or predict. In general, economists say, they reflect the long-term earnings potential of companies. Investors are attracted to stocks of companies they expect will earn substantial profits in the future; because many people wish to buy stocks of such companies, prices of these stocks tend to rise. On the other hand, investors are reluctant to purchase stocks of companies that face bleak earnings prospects; because fewer people wish to buy and more wish to sell these stocks, prices fall.
Each stock has an intrinsic value as well as a market price.
The intrinsic value is normally calculated by analysts who use current data to estimate a stock's "true" value. The market price of a stock is the actual price the stock is trading at in the stock market.
It is easy to find actual stock prices. All you have to do is visit sites like finance.yahoo.com or read the Wall Street Journal.
Intrinsic values on the other hand are estimates and it is these values that drive you the investor to either buy, sell or be indifferent to a stock. Much more of this will be discussed later.
Bull and Bear Markets
Historically, the stock market has tended to operate within certain cycles of activity. The two most common cycles are:
Types of Stock Market Transactions
There are three types of Stock Market transactions that you need to be aware of:
1. Outstanding shares of existing public owned companies that are traded in the secondary market.
Going with our example earlier about buying Google stock; Google has about 317 million outstanding shares (based on 2009 q3 results). If you the investor sells 100 shares of Google stock; you would be trading in what is called the secondary market.
Google would never receive new money for this sale. This is the market for outstanding shares.
2. Additional shares sold by publicly traded companies in the primary market. Let's say that Google needs to raise money (equity).
To do so, the company decides to issue or sell 10 million shares. Google would sell its shares in the primary market.
3. Initial Public Offerings in the IPO market. When a privately held company decides to go public, one of the first things the company does is offer its shares for sales in the IPO market to the public through what is called an initial public offering (IPO).
The goal is to raise capital so that the company can expand their core business. Companies like Google first offered their shares to the public in 2004 at the price of $85 per share. Today the stock sells at $600+.
Measuring the Market
An important part of this overview is understanding the performance of the stock market. Stock Indexes are used to show how the Stock Market is performing. The most common indexes that we all know are:
Dow Jones Industrial Average
S&P 500 index
Nasdaq composite index
An understanding of the stock market basics is important. It lays the foundation for stock investing as a beginner.