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Over the past few years the stock market has made
substantial declines. Some short term investors have lost a good bit
of money. Many new stock market investors look at this and become
very skeptical about getting in now.
If you are considering investing in the stock market it is very
important that you understand how the markets work. All of the
financial and market data that the newcomer is bombarded with can
leave them confused and overwhelmed.
The stock market is an everyday term used to
describe a place where stock in companies is bought and sold.
Companies issues stock to finance new equipment, buy other
companies, expand their business, introduce new products and
services, etc. The investors who buy this stock now own a share of
the company. If the company does well the price of their stock
increases. If the company does not do well the stock price
decreases. If the price that you sell your stock for is more than
you paid for it, you have made money.
When you buy stock in a company you share in the profits and losses
of the company until you sell your stock or the company goes out of
business. Studies have shown that long term stock ownership has been
one of the best investment strategies for most people.
People buy stocks on a tip from a friend, a phone call from a
broker, or a recommendation from a TV analyst. They buy during a
strong market. When the market later begins to decline they panic
and sell for a loss. This is the typical horror story we hear from
people who have no investment strategy.
Before committing your hard earned money to the stock market it will
behoove you to consider the risks and benefits of doing so. You must
have an investment strategy. This strategy will define what and when
to buy and when you will sell it.
History of the Stock Market
Over two hundred years ago private banks began to sell stock to
raise money to expand. This was a new way to invest and a way for
the rich to get richer. In 1792 twenty four large merchants agreed
to form a market known as the New York Stock Exchange (NYSE). They
agreed to meet daily on Wall Street and buy and sell stocks.
By the mid-1800s the United States was experiencing rapid growth.
Companies began to sell stock to raise money for the expansion
necessary to meet the growing demand for their products and
services. The people who bought this stock became part owners of the
company and shared in the profits or loss of the company.
A new form of investing began to emerge when investors realized that
they could sell their stock to others. This is where speculation
began to influence an investor's decision to buy or sell and led the
way to large fluctuations in stock prices.
Originally investing in the stock market was confined to the very
wealthy. Now stock ownership has found it's way to all sectors of
our society.
What is a Stock?
A stock certificate is a piece of paper declaring that you own a
piece of the company. Companies sell stock to finance expansion,
hire people, advertise, etc. In general, the sale of stock help
companies grow. The people who buy the stock share in the profits or
losses of the company.
Trading of stock is generally driven by short term speculation about
the company operations, products, services, etc. It is this
speculation that influences an investor's decision to buy or sell
and what prices are attractive.
The company raises money through the primary market. This is the
Initial Public Offering (IPO). Thereafter the stock is traded in the
secondary market (what we call the stock market) when individual
investors or traders buy and sell the shares to each other. The
company is not involved in any profit or loss from this secondary
market.
Technology and the Internet have made the stock market available to
the mainstream public. Computers have made investing in the stock
market very easy. Market and company news is available almost
anywhere in the world. The Internet has brought a vast new group of
investors into the stock market and this group continues to grow
each year.
Bull Market - Bear Market
Anyone who has been following the stock market or watching TV news
is probably familiar with the terms Bull Market and Bear Market.
What do they mean?
A bull market is defined by steadily rising prices. The economy is
thriving and companies are generally making a profit. Most investors
feel that this trend will continue for some time. By contrast a bear
market is one where prices are dropping. The economy is probably in
a decline and many companies are experiencing difficulties. Now the
investors are pessimistic about the future profitability of the
stock market. Since investors' attitudes tend to drive their
willingness to buy or sell these trends normally perpetuate
themselves until significant outside events intervene to cause a
reversal of opinion.
In a bull market the investor hopes to buy early and hold the stock
until it has reached it's high. Obviously predicting the low and
high is impossible. Since most investors are "bullish" they make
more money in the rising bull market. They are willing to invest
more money as the stock is rising and realize more profit.
Investing in a bear market incurs the greatest possibility of losses
because the trend in downward and there is no end in sight. An
investment strategy in this case might be short selling. Short
selling is selling a stock that you don't own. You can make
arrangements with your broker to do this. You will in effect be
borrowing shares from your broker to sell in the hope of buying them
back later when the price has dropped. You will profit from the
difference in the two prices. Another strategy for a bear market
would be buying defensive stocks. These are stocks like utility
companies that are not affected by the market downturn or companies
that sell their products during all economic conditions.
Brokers
Traditionally investors bought and sold stock through large
brokerage houses. They made a phone call to their broker who relayed
their order to the exchange floor. These brokers also offered their
services as stock advisors to people who knew very little about the
market. These people relied on their broker to guide them and paid a
hefty price in commissions and fees as a result. The advent of the
Internet has led to a new class of brokerage houses. These firms
provide on-line accounts where you may log in and buy and sell
stocks from anywhere you can get an Internet connection. They
usually don't offer any market advice and only provide order
execution. The Internet investor can find some good deals as the
members of this new breed of electronic brokerage houses compete for
your business!
Blue Chip Stocks
Large well established firms who have demonstrated good
profitability and growth, dividend payout, and quality products and
services are called blue chip stocks. They are usually the leaders
of their industry, have been around for a long time, and are
considered to be among the safest investments. Blue chip stocks are
included in the Dow Jones Industrial Average, an index composed of
thirty companies who are leaders in their industry groups. They are
very popular among individual and institutional investors. Blue chip
stocks attract investors who are interested in consistent dividends
and growth as well as stability. They are rarely subject to the
price volatility of other stocks and their share prices will
normally be higher than other categories of stock. The downside of
blue chips is that due to their stability they won't appreciate as
rapidly as compared to smaller up-and-coming stocks.
Penny Stocks
Penny Stocks are very low priced stocks and are very risky. They
are usually issued by companies without a long term record of
stability or profitability.
The appeal of penny stock is their low price. Though the odds are
against it, if the company can get into a growth trend the share
price can jump very rapidly. They are usually favored by the
speculative investor.
Income Stocks
Income Stocks are stock that normally pay higher than average
dividends. They are well established companies like utilities or
telephone companies. Income stocks are popular with the investor who
wants to own the stock for a long time and collect the dividends and
who is not so interested in a gain in share price.
Value Stocks
Sometimes a company's earnings and growth potential indicate
that it's share price should be higher than it is currently trading
at. These stock are said to be Value Stocks. For the most part, the
market and investors have ignored them. The investor who buys a
value stock hopes that the market will soon realize what a bargain
it is and begin to buy. This would drive up the share price.
Defensive Stocks
Defensive Stocks are issued by companies in industries that have
demonstrated good performance in bad markets. Food and utility
companies are defensive stocks.
Market Timing
One of the most well known market quotes is: "Buy Low - Sell
High". To be consistently successful in the stock market one needs
strategy, discipline, knowledge, and tools. We need to understand
our strategy and stick with it. This will prevent us from being
distracted by emotion, panic, or greed.
One of the most prominent investing strategies used by "investment
pros" is Market Timing. This is the attempt to predict future prices
from past market performance. Forecasting stock prices has been a
problem for as long as people have been trading stocks. The time to
buy or sell a stock is based on a number of economic indicators
derived from company analysis, stock charts, and various complex
mathematical and computer based algorithms.
There are numerous risks involved in investing in the stock market.
Knowing that these risks exist should be one of the things an
investor is constantly aware of. The money you invest in the stock
market is not guaranteed. For instance, you might buy a stock
expecting a certain dividend or rate of share price increase. If the
company experiences financial problems it may not live up to your
dividend or price growth expectations. If the company goes out of
business you will probably lose everything you invested in it. Due
to the uncertainty of the outcome, you bear a certain amount of risk
when you purchase a stock.
Stocks differ in the amount of risks they present. For instance,
Internet stocks have demonstrated themselves to be much more risky
than utility stocks.
One risk is the stocks reaction to news items about the company.
Depending on how the investors interpret the new item, they may be
influenced to buy or sell the stock. If enough of these investors
begin to buy or sell at the same time it will cause the price to
rise or fall.
One effective strategy to cope with risk is diversification. This
means spreading out your investments over several stocks in
different market sectors. Remember the saying: "Don't put all your
eggs in the same basket".
As investors we need to find our "Risk Tolerance". Risk tolerance is
our emotional and financial ability to ride out a decline in the
market without panicking and selling at a loss. When we define that
point we make sure not to extend our investments beyond it.
Benefits
The same forces that bring risk into investing in the stock market
also make possible the large gains many investors enjoy. It's true
that the fluctuations in the market make for losses as well as gains
but if you have a proven strategy and stick with it over the long
term you will be a winner!
The Internet has make investing in the stock market a possibility
for almost everybody. The wealth of online information, articles,
and stock quotes gives the average person the same abilities that
were once available to only stock brokers. No longer does the
investor need to contact a broker for this information or to place
orders to buy or sell. We now have almost instant access to our
accounts and the ability to place on-line orders in seconds. This
new freedom has ushered in new masses of hopeful investors. Still
this in not a random process of buying and selling stock. We need a
strategy for selecting a suitable stock as well as timing to buy and
sell in order to make a profit.
Day Trading
Day Trading is the attempt to buy and sell stock over a very
short period of time. The day trader hopes to cash in on the short
term fluctuations in a stock's price. It would not be unusual for
the day trader to buy and sell the same stock in a matter of a few
minutes or to buy and sell the same stock several times a day.
Day traders sit in front of computer monitors all day
looking for short term movement in a stock. They then attempt to get
in on the movement before it reverses. The real day trader does not
hold a stock overnight due to the risk of some event or news item
triggering the stock to reverse direction. It takes intense
concentration to monitor the minute by minute movement of several
stocks.
Day trading involves a great deal of risk because of the uncertainty
of the market behavior over the short term. The slightest economic
or political news can cause a stock to fluctuate wildly and result
in unexpected losses.
There are a few people who make respectable gains day trading. The
people who probably make the most are the self proclaimed "experts"
who sell the books or operate the web sites that cater to the day
trader. Because of the profits to be made from sales to people who
want to get rich quick, they make it seem as attractive as possible.
The truth is that in the long run more people lose than gain by
day trading.
This does not translate into a very good investment.
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