Stock Market Basics – Quick Start Learning Guide

This article will provide you a whirlwind introduction to the basics of the stock market.  It will answer for you core questions you may have, such as:

  • What is a Stock Market?
  • What are the best Stock Markets to invest in?
  • How does the stock market work?
  • What is a stock market index?
  • What types of stock can you buy?
  • What makes stock prices so up or down?
  • What is a hedge fund?
  • How to buy stocks for dividends
  • Who should you trust with your money?
  • What is Stock Analysis?

Stock Market Basics: What is a Stock Market?

There are many Stock Markets in the world and they have essentially been established to allow business to get cheap financing to aid rapid expansion in exchange for a slice of the business and an opportunity to profit with the business.  The largest stock markets are located in the richest countries, this enables business to get access to the wealth and capital available in these countries to finance growth

The worlds major Stock Markets

The World Federation of Exchanges (WFE) regulates 52 Stock Exchanges across the globe promoting regulatory standards.  Below you can see the list of the major exchanges regulated and reported on.  I have sorted this list on the Domestic Market Capitalization.  This Capitalization is the value of all the shares traded on the exchange.

Interesting Points To Note
  • The biggest stock exchange in the world is the New York Stock Exchange (NYSE Eurnext) with a total value of over $13 Trillion Dollars
  • The 2 largest exchanges in the world are the US NASDAQ the US NYSE – the combined value of these two exchanges is equal to the value of the next 6 smaller exchanges (Tokyo, London, Hong Kong, NYSE Euronext Europe, Shanghai and the TSX Group)
  • The NYSE & NASDAQ account for roughly 40% of the value of the Global Stock Markets
  • The 52 Regulated Exchanges have a combined value of $51,7 Trillion Dollars
  • The top 10 exchanges account for over 70% of the capitalization of the global markets

What are the best stock markets to invest in?

In terms of regulation and choice, the US and European Stock Market are the place to go, with vast numbers of companies floated on these exchanges you can always find companies that meet your criteria.

Stock Market Basics: How does the Stock Market Work?

By purchasing stock in a company you can benefit in two ways.  Firstly you can benefit from share price appreciation, the movement of the stock price up.  Secondly you can benefit if the company issues dividend payments.  Dividend payments are a cash distribution of profits as a reward to shareholders for holding the stock.  Wall Street analysis firms provide ratings of the companies and their stocks, however they can be quite misguided and they are more often than not more bullish than they should be.

Institutional Stock Analysis- Wall Street Analysts

Most of the investment banks and brokerage houses employ Stock Market Analysts. Their job is to research the firms in the industry they are allocated to, in an attempt to assess if the companies are worth investing in.  You can purchase the “Analyst Reports” from S&P, Moodys, The Street, Credit Suisse or the plethora of other information providers out there.  The analysts usually attend the shareholder meetings for the companies they cover and probe the management team for further information.  Wall Street analysts come under constant scrutiny for the meaningless jargon and inaccurate ratings they put on stocks.  There is no aligned meaning across the research houses as to the meaning of ratings such as:

  • Strong Buy, Hold, Sell, Strong Sell
  • Outperform, Perform, Under perform
  • Overweight, Underweight
  • Long, Neutral, Avoid
  • Accumulate, Hold, Distribute

The analysts tend to avoid negative opinions as they tend to receive flack from the management teams and pressure that they may lose access to the companies they cover.  Analysts are not paid for the performance of their stock ratings; therefore they have limited motivation to be really truthful.

Stock Market Basics: What is a stock market index?

All of the stocks listed by a given stock exchange are then categorized into various indices.  This enables the relative performance of different types of stocks to be compared and contrasted.

In the U.S.  there are different market indices targeting different sized companies and types of businesses.

S&P 500 – The Standard & Poors 500

This market index is a listing of the top 500 companies in the U.S.A based on market capitalization.  Market Capitalization is the value of all the publicly traded shares of a company multiplied by the share price.  This market index is probably the most widely followed index and is considered as a benchmark index for the U.S.  The index comprises heavy weight corporations like Apple Inc. (ticker:APPL) valued at $432 billion (at the time of writing) to Advanced Micro Devices (ticker:AMD) valued at $1.9 billion.  It is a capitalization weighted index. See below

DJ30 – Dow Jones Industrial Average

This market index was established in May 1896 by Charles Dow.  Referred to as the Dow or the Industrials, this market index has non heavy industry components such as Microsoft (ticker:MSFT) and JP Morgan (ticket:JPM).  However, it does still contain the industry heavyweights such as Exxon Mobil Corp (ticket:XON) valued at $403 billion and Alcoa (ticker:AA) valued at $9.9 billion. The DJ30 is a price weighted market index.

Other Popular Market Indices

  • Dow Jones 15 Utility Component Index – This market index comprises the top utility companies in the U.S.
  • Dow Jones 20 Transports – Comprising Airline, Railroad, Trucking and Postal companies.
  • NASDAQ 100 – The top 100 largest capitalization non financial stocks listed on the NASDAQ Stock Exchange.
  • NASDAQ Composite – All of the Securities and stocks listed on the NASDAQ Stock Exchange.
  • Russell 3000 – This market index comprises the top 3000 stocks in the U.S. based on market capitalization.  This covers almost 98% of the value of U.S. Traded stocks.  So if you want to view the entire market this is the index to check.
  • Standard & Poors 400 MidCap – Mid sized Capitalization stocks.
  • Standard & Poors 600 SmallCap – Smaller capitalization stocks are listed in this market index.  This could refer to start up companies and growth companies in the early stages of development.

Capitalization Weighted Index

A capitalization weighted index means the index is calculated based on the total market value of all the stocks in the index.  This means that stock price changes in the largest companies with the largest market capitalization’s will have a larger effect on the movement of the index.

Price Weighted Market Index

A price weighted index is a market index that is calculated not on the overall equity or capitalization of the listed companies, but instead on the price of the stock.  This means that the weighting of the index is dependent on the stock’s price, this can lead to confusion as a smaller company with a stock price of $200 will have a larger impact on the movement of the index than a larger company with a stock price of $10.

Stock Market Basics: What types of stock can you buy?

Not all stocks are created equally.  There are actually two main stock types, find out the differences below.

What is the difference between Common Stock and Preferred Stock?
Common Stock

Common stock is the most commonly available type of stock.  This is what you would typically purchase when buying through brokers.  It represents a stake in the company.  If there are 10 million shares available for a company on the market.  If you purchased 1 million of them this would essentially give you a 10% stake in the business.  Along with purchasing common stock, you will get other benefits such as voting rights and the rights to receive any paid dividends.  The voting rights will give you a voting in the election of the board of directors and corporate policy.

One of the negatives of owning common stocks in comparison to being an owner of corporate bonds, a debt holder or owning preferred stock is that you are further down in the pecking order to receive your investment back should the company go into liquidation.

The biggest benefits of being a common stock holder is that you will benefit the most from the growth in share price.  Being normally floated on the major indices, common stocks are usually liquid, meaning that there are usually buyers and sellers at hand to ensure the stock is priced fairly.

Preferred Stock

Preferred stock is the type of stock that has more benefits in terms of claims on the underlying assets of the business in comparison with common stock.  It is important to read the small print when buying preferred stock as the exact rights of preferred stocks vary from company to company.  In general the structure of the agreement will exclude voting rights and include a higher priority on dividend payments versus common stock holders.

One drawback apart from the lack of voting rights, is that the preferred stock may not be available on the open market, meaning that it may not appreciate as much common stock and might not have the required amount of liquidity if you wish to sell.

Stock Market Basics: What makes stock prices so up or down?

A very common question I get is, “What makes stock prices go up or down?”.  Put another way,  “Why do stock prices move?”

Although it may seem like a difficult question it is quite straightforward.

Stock prices move due to differences in supply and demand.

The reasons for the differences in supply and demand are where the real details lie.  Many factors change the supply demand equation.

Equilibrium – Normal Demand – Normal Supply

This scenario represents an equilibrium between buyers and sellers.  This is when a stock is moving sideways on a stock chart neither trending strongly upwards or downwards.  There is no pressure on supply or demand in either direction.  On a stock chart we would tend to see an average day of volume and muted price movements.  If the market is overall up for the day you might see some upward drift of the stock price, there will also be no significant news that might sway the stocks or demand supply in either direction.

Low Demand – Low Supply
This is a day in the stock market where we see disinterested buyer and sellers.  Typical volatility is low, there is little movement in the stock price and the volume bars are lower than normal.
High Supply – High Demand
In this scenario we will see significantly higher volume of trades.  This means that the buyers are buying heavily and the sellers are equally selling heavily.  This means in a stock chart we might see some change in the stock price in either direction but we would definitely see a huge volume bar.  If you view candle sticks you might see what is called a Doji. This means that the increased volumes cause sizable price moves but the opening price and the closing price at the end of the day ended at a very similar level.  This is typically a pattern that suggests a change in trend.  From Up to Down, Down to Up, or Up or Down to Sideways.
Supply Side Pressure
High Supply – Low Demand

Here the study of supply and demand starts to get very interesting.

Imagine for example, a company announces very poor earnings for the quarter and suggests that the outlook is poor.  Investors who hold the stock suddenly realize that their money could be better invested elsewhere.  They start to sell the stock stock at market price.  As the news of the company’s poor earnings get digested the buyers who where once interested in owning the stock suddenly start to back away from purchasing the stock.  This causes a low demand for the stock.  When that is combined with the high supply the stock starts to plummet.  The stock will fall to a point where the potential buyers start to feel the price is at a level where there is value in it.   See point 2 in the NETFLIX Stock Chart Below. Point 2 Blow Off Top.  We see a surge in volume and a huge drop in stock price.

Chart NETFLIX Ticker NFLX.

Demand Side Pressure – High Demand – Low Supply

Lets take the opposite side of the story.  Lets say a company has just announced a record quarter and predicts a Rosy outlook for the future.  Those who own the stock are excited and expect to see further appreciation of their investment.  Those who have been following the stock see this as the signal to start buying the stock.  Those who own the stock are reluctant to sell as they expect more price appreciation, this restricts supply.  Those who want to own the stock are therefor willing to pay more to entice further sellers into the market.  This boosts the stock price significantly.  In a stock chart we will see a huge volume bar and a jump in the stock price.  See Point 3. Massive Buying in the Netflix chart

This gives you a good understanding of what makes a stock price move.  But there are many more factors to stock price movements that just earnings and positive outlooks.

Here are some other factors that play an important role:

  • Investor Sentiment & Expectation
  • M&A Activity – Expected Takeover Target
  • Industry Strength – the industry itself is hitting a growth cycle.
  • Market Dominance – company has developed a leveragable market dominance
  • Competitor Weakness – weak competition and failure of competitors opening up new market share opportunities
  • New Product Introductions – innovative product launches
  • Analyst Upgrades or Downgrades, these should always be viewed with scepticism
  • Political or legislative changes that affects a companies product or business model

Whatever causes the supply and demand equation to change.  We should be able to see it in the stock charts and act accordingly.

Do not forget that nearly all stock charts and indicators are based on two things only:

    • Stock Price (Open, High, Low, Close)
    • Volume

Stock Market Basics: What is a hedge fund?

What is a hedge fund, and how to they make money?
A hedge fund is designed for sophisticated investors or higher net worth individuals.  As such there are usually higher entry costs, such as a minimum investment of $50,000 or $100,000 to get started in a fund.

The funds are usually aggressively managed to try to ensure maximum returns that should, in theory, significantly beat the index they are benchmarked against.  Unlike mutual funds they may not specify a particular asset or investment style that they wish to stick to.  This enables them to remain flexible and adopt any investing tactic that suits the current market conditions.  At any given point a hedge fund may be:

  • Long – betting the market or underlying assets will increase in value
  • Short – betting the assets will decrease in value
  • Highly Leveraged – meaning for every $1 they have in actual capital they may borrow $10 to maximize their returns, this is 10X Leverage
  • Investing in Currencies, Property, Commodities, Stocks, ETF’s and other even more exotic instruments like Credit Default Swaps (CDS) or Collateralized Debt Obligations (CDO’s)
  • High Frequency Trading – using computers to arbitrage deals at a very high frequency. For example.  If gold sells at $1600 an ounce in the U.S. and $1590 an ounce in Australia, they may choose to buy in Australia and sell the gold in the U.S. for a $10 per ounce profit.

As a reward for the aggressive investment the Hedge fund will usually see a 2 and 10 cost structure.  This means they will charge the investor a 2% annual charge on the entire investment you have made, and also keep 10% of the profits they have made with your money.

Stock Market Basics: How to buy stocks for dividends

What are dividends?
Of the 5800+ stocks currently available to purchase on the major U.S. indices circa 2800 companies currently offer a dividend payout.

A dividend is an offer from the company to payout a portion of its income (after tax profits) to its shareholders.

These companies tend to be well established with a stable income stream enabling them to offer a constant dividend.  The dividend is essentially a reward to the shareholder for holding the stock.

Types of Dividend
Regular Cash dividend, the most common type of dividend payment, usually released quarterly.
Extra dividend, a special dividend usually a large one off payment to shareholders
Liquidating dividends usually paid if there are any left-over or allocated funds during the company’s liquidation.
Dividend Payment
The dividend payment is usually expressed in dollars per share.  This means if I own 100 shares of a company whose stock price is $200, if the company pays out $5 per share then I will receive 100 X $5 = a $500 payment.  Usually this is distributed on a quarterly basis, meaning I will receive $125 per quarter.

Dividend Payment = Number of Shares X Payment per Share

Dividend Yield
Here is an example of the dividend Yield.  I own 1000 shares of ABC Company at a cost of $10 per share.  ABC pays out a regular dividend of $0.50 per share.  As a single share of the company is worth $10, $0.50 equates to a dividend yield of 5%.

Dividend Yield = Annual Dividend Paid / Stock Price

This 5% is essentially what you earn on your money regardless of stock price growth.  Of course if the stock price deteriorates during the period in which you hold the stock this may mean your net profit reduces.  For example, your make a 5% profit in terms of dividend yield, yet the stock price has depreciated 5%.  This means your net profit if you were to sell would be Zero.

Dividend Payout Ratio
This is the proportion of the Earnings per Share (EPS) that is paid out in dividends.  For example if a company earns $2.50 in earning for every outstanding start, and it pays out $0.50 per share in dividends, then the dividend payout ratio is 20%.

Dividend Payout Ratio = Dividends per Share / Earnings per Share

Ex-Dividend Date
This is the date 2 business days prior to when the dividend payment is scheduled.

For example if you purchase a stock on April 24th and the company announces the dividend payment date is April 30th, then you will be entitled to the dividend.  However if you purchased the stock on the 29th of April, then the previous owner of the stock will receive the dividend.

What kind of Dividend Payouts Can You Expect?
Of the 5000+ stocks currently on the major U.S. Indices approximately 50% of the companies pay out a dividend.  Here are some interesting facts.

There are 2800 companies paying a dividend
Less than 0.5% pay-out a dividend of more that 10%
25% of the companies pay out a dividend yield of between 5% and 10%
Less than 1% of companies pay a dividend of less than 1%
This means approximately 74% of the companies pay between 1% and 5%
A reasonable expectation is that you should receive a dividend of around 5%.

Dividends can be a great way to generate a steady income from stocks, but beware, if a stock price is rapidly falling and the company is in trouble your net profit may not be as high as you expect.

Stock Market Basics: Who should you trust with your money?

Over the last 50 years we have been indoctrinated to hold professional people in high esteem, a job in banking was respected and working as an Financial Investment Adviser meant you understood how to invest money on behalf of your clients. But over the last two years we have seen this stripped away to reveal the truth, they are only human and humans have flaws, plenty of them!

Bankers once renowned and respected for being conservative with other people’s money were no longer conservative. They nearly lost it all. Money in the bank was supposed to be a safe haven, yet it had been completely risked. Searching for ever increasing profits they took risks with our money and never told us. Now they are too conservative, being too scared to lend money to the very businesses that keep our whole economy going. All this whilst having their profits bolstered by an extremely low cost of money (Fed Funds Rate, Bank of England base rate). They are getting the money at practically no cost while lending it out at still pre-crisis rates. You try getting a loan under 4%.  All this while they are starting to pay themselves big bonuses again.

Financial advisers who talked about risk management squarely to not understand risk.  Just before the Financial Crisis struck, record numbers of Newsletter writers, Hot Stock Tipsters, TV Pundits were all still bullish. Even when the crisis struck, if you had called your adviser he would have told you to “stay with your funds”, “do not do anything”, or if you really insisted you wanted to move to safety it is then you find out that you cannot as you are stuck in a fund for a “minimum period” and if you moved out there would be a “penalty”.   How is that managing risk?  Managing risk also should mean you have the ability to move funds quickly with no cost to avoid demolition to your retirement fund.

This exactly happened to my father, he was injured in a horrific workplace accident and had to retire handicapped early. He received a small award from the courts to compensate him for the pain (just enough to live on) .  I took him to see the most respected Financial Advisers in his area. With their fancy offices and rows of Audi’s in the car park, my father was quickly convinced these people would conservatively invest his money, to enable him to live out the rest of his life with less money worries.  He needed to focus on assisting my mother who also has health issues.

BOOM financial crisis.

50% of his original investment has vanished. He could not get out of the contracts and now he needs to hope the markets recover to pre-crisis levels before he even see the amount he invested. This could be 3 to 5 years if he is lucky.  In the meantime he is drawing down this reduced amount just to cover his living expenses, this money he will never get back.

My point here is simple.  Financial advisers in general are experts in selling you funds, pensions and insurance they are not experts at understanding what way the market is heading and if those funds will make you any money at all.  However they are also experts in taking a fixed percentage of your money every year whether you make a profit of not.  So to them the main focus is on how much money they can manage so they see a percentage of that portfolio come into their business as revenue.

Take control.

Now is the time to take control, you are probably visiting this site because you want to take control.  You want to understand.  You want to make the decisions.  This site is dedicated to stock trading, however all the principles you will learn here can be applied to Mutual Funds, ETF, Stock Market Tracker Funds and investments in general.  Wouldn’t you like to know how to evaluate whether the ETF or Mutual Fund your adviser is recommending has any change of making money in the near to medium future.

Who can you ultimately trust with your finances. You and only you.

Stock Market Basics: What is Stock Analysis?

Stock Analysis. What is stock analysis and how is it done?

Since the publication of the classic book by Benjamin Graham in 1934 called “Security Analysis”, an entire industry has built up around the analysis of stock market investments.

There are various methods used to evaluate the past, present and future performance of stocks from professional analysis to private stock pickers.  Methods employed use primarily two approaches, Fundamental Analysis or Technical Analysis.

Institutional Stock Analysis.  Wall Street Analysts

Most of the investment banks and brokerage houses employ Stock Market Analysts. Their job is to research the firms in the industry they are allocated to, in an attempt to assess if the companies are worth investing in.  You can purchase the “Analyst Reports” from S&P, Moodys, The Street, Credit Suisse or the plethora of other information providers out there.  The analysts usually attend the shareholder meetings for the companies they cover and probe the management team for further information.  Wall St analysts come under constant scrutiny for the meaningless jargon and inaccurate rating they put on stocks.  There is no aligned meaning across the research house as to the meaning of ratings such as:

  • Strong Buy, Hold, Sell, Strong Sell
  • Outperform, Perform, Under perform
  • Overweight, Underweight
  • Long, Neutral, Avoid
  • Accumulate, Hold, Distribute

The analysts tend to avoid negative opinions as they tend to receive flack from the management teams and pressure that they may lose access to the companies they cover.  Analysts are not paid for the performance of their stock ratings, therefore they have limited motivation to be accurate.

“Wall Street Analysts are bad at stock picking”

Stephen T McClennan – Book Full of Bull

Does “Buy” really mean buy the stock.  What if the highest rating used is Strong Buy.  Does that mean that buy is more negative than Strong Buy?

Wall Street is oriented towards increasing stock prices, they have to be positive in order to convince people to continue buying.

In a 2006 CFA Magazine Research article by Mike Mayo it was noted that of the recommendations on the Top 10 Largest Cap stocks in the U.S.  there were 193 Buy Ratings and only 6 Sell Ratings.  Systemic Bias….?

Stephen T McClennan – Book Full of Bull

Do not take analyst ratings as literal, you cannot rely on them.

Stock Newsletters – Stock Pickers

There are also many newsletter services available where you can register to receive stock recommendations.  You will usually receive a daily or weekly newsletter that recommends what to buy and sell.  They come in two flavours, “Free Newsletters” and “Pay for Services”.

At all costs avoid any Free Stock Tips Newsletters.  The companies that run free newsletters provide biased data as they earn there money form the companies they promote.  They will often by paid by the companies they promote with stock options.  So if they promote the stock well enough they can sell their options as the price rises therefore making money at your expense.

 

 

Premium Newsletter can be a reasonable source of good information, but you have to research the track record of the person providing the tips.  Ensure they beat the market year after year.  At least 90% of stock tippers do not beat the market regularly.

Be your own Stock Analyst.

We recommend the best way to improve your profits and success in the market is to invest in yourself and make your own decisions.  When it comes to your own money, you can only trust yourself.  Make a good investment in stock market education and spend the time to use Fundamental and Technical Analysis to make informed decisions in the stock market.

For further reading I highly recommend the book Full of Bull, by Stephen T. Mclennan

Stock Market Basics: Summary

The world of stock market investing is huge.  This article provides an introduction to the basics of stock markets and how they work.  This website is a huge resource for learning about the stock market.  We have a 10 Module Training Course for Free, to help guide you through the maze of knowledge required.

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Stock Market Basics - Quick Start Learning Guide
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Stock Market Basics - Quick Start Learning Guide
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An Awesome Step By Step Guide to Learn the Basics of the Stock Market. How do they work, What are Stocks, dividends & indices? What makes stocks move?
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LiberatedStockTrader.com
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