What exactly is the stock market? At a basic level an individual or group start a company. After they have grown the business for some time, a company will begin to seek outside capital (cash) to help fund their growth. In exchange for investors capital the company makes them a partial owner of the company giving them stock in the company. Often these early investors are friends and family of the founders. As growth continues the company may decide to “go public” selling a large quantity of shares to the general public. This is usually done through an “Initial Public Offering”, usually referred to as an “IPO”. The company is issued a “Stock Symbol”, also known as a “Ticker Symbol” which is an abbreviation used to uniquely identify shares of stock of a particular company. The companies stock symbol may consist of letters, numbers, or a combination of both.
A person who owns shares are referred to as “shareholders”. After the IPO those who own the shares are then free to buy and sell these shares to others. If I own a share and I to sell it, I must determine what price I am willing to sell it for. Of all the people who are willing to share stock in that company, whoever has the lowest sells price is known as the “Ask” price. Of all the people who are willing to buy a share of stock in that company, whoever has the highest offer is known as the “Bid” price. When the bid and ask price are the same a sale happens, money is exchanges and the share(s) are transferred. The stock price you see is on financial websites is the last agreed upon price. For most large companies these sales happen many times a second. The number of issued shares multiplied by the current stock price is referred to as the “market capitalization” often shorted to “market cap” of a company. A stock market exchange is setup to simplify the process for buyers and sellers. They act as an intermediary between buyers and sellers so that rather than having to find a seller to buy from or a buyer to sell to stock market exchanges handle that for us. The two largest stock market exchanges in the United States are the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq), both based in New York.
Shareholders invest in companies because they want to make money. Shareholders make money in various ways. These include dividends, growth in the value per share of a stock, share buyback agreements, and options premium. A dividend is a payment from a company to its shareholders, usually as a distribution of profits. Company are not required to pay dividends, but many large companies do. Dividends can be paid at whatever schedule the company’s board of directions determines, but most companies that pay dividends do so on a quarterly basis. I recommend that you automatically reinvest any dividends you receive back in the company that issues them. This is referred to as a “Dividend ReInvestment Program”, usually shorten to “DRIP”. Most brokerages do not charge any commissions or frees for DRIP. I will talk more about dividends in other posts. Nearly every investor hopes that the company’s who shares they invest in increase in value. If you invested in a company and it was $15 per share yesterday and today it is trading for $15.50, you have experienced growth in the value per share. This is unrealized growth until you sell it as the shares could trade for $14.99 tomorrow. Companies will periodically decide to reduce the number of outstanding shares. They will do this by buying back shares. This share reduction causes each share to have a higher percentage of ownership and, by extension, claim of profit in the company. Share Buyback usually leads to share value growth. Options trading is another way that investors make money in the stock market. I wouldn’t recommend as a new investor you do anything with options at this stage of your investment life. If you would like to read some basics about options visit my Options Basics.
Sometimes investors decide that an individual stock or the stock market as a whole is undervalued and will cause the stock or the whole market to get more expensive. Likewise, sometimes investors decide that an individual stock or the stock market as a whole is overvalued and will cause the stock or the whole market to get cheaper. When a stock or the market goes up it is referred to as a “bull” and when it is declining it is referred to as a “bear”. For new investors this can be unnerving. Let’s take a step outside of the stock market for a moment and pretend you are selling a car. Someone texts you and says they are willing to buy your car from you. You are asking $5,000 for your car. This interested buyer, we’ll call him Mr. Market, tells you that you are crazy and that your car is only worth $4,000 and they’ll give you $4,000 right now for it. You tell him no. Every few minutes he sends you a new price that he is willing to pay for it. One minute he believes it is worth $4,000, then suddenly $4,500, then $3,875, then $5,100, then $4,999, then $5,050, and finally $2,995. Has the value of your car changed? No, but what Mr. Market is willing to pay for it has. Mr. Market isn’t actually telling you what your car is worth, but rather what he is willing to pay for it. This holds true for the stock market. A new investor sees a stock price jumping a lot and they get excited and they don’t want to miss this great deal. They “buy the car” when it is at $5,100 and then gets scared and sell it when it is at $2,995. They then say that stock market investing is a scam or only for rich people and won’t buy it again. In the coming pages I will share what to do instead.
I originally wrote this page as part of a short book on beginning investing that I am writing.
This post was originally written on January 8, 2019, and is not intended to convey legal, accounting, investing, or other professional advice. I’m not selling anything. I am not a registered stock dealer or broker or anything like it. I’m just sharing ideas I have in stock market investments. My ideas are subject to change at anytime. I have not been compensated in anyway for any of Mike’s Stock Picks.