This article is a primer in stock trading basics for those interested in making money buying and selling stocks. We look at just what is a stock, what kinds of stocks are there, how trading works and the reasons that stock values go up and down.
What Is a Stock?
A stock is a share of a company. It gives the owner a claim on company earnings and assets. The more shares of stock you own the more your claim. Owning a share of stock typically gives you a vote in who runs the company and various other rules and regulations. A share of stock has a price that you pay when you buy and that you receive when you sell. Stocks are traded on stock exchanges like the New York Stock Exchange or the NASDAQ.
Kinds of Stocks
The two kinds of stock are common and preferred. The vast majority of people own and or trade common stock. Common stock gives you a claim on company assets and voting rights. The goal in long term ownership is to hang on while the value of the asset appreciates. The goal of trading is to buy and sell in a timely fashion and take advantage of swings in the value of the stock. Preferred stock commonly does not give a person voting rights. But preferred stock often provides a fixed permanent dividend and in the event that the company goes out of business, preferred stock owners are paid off before common stock owners but after bond holders. A potential drawback to owning preferred stock is that the company often has and exercises the right to buy back the stock without asking for your permission.
The Mechanics of Trading Stocks
Most stocks are traded on stock exchanges but some are traded over the counter. Trading over the counter stocks can be a problem because of reduced volume and liquidity of the stock in question. Markets have been around for centuries and are meant to facilitate the exchange of securities between the buyer and the seller. US markets like the NASDAQ and New York Stock Exchange have strict rules regarding which stocks can be listed and offer very transparent trading. This reduces your risk while trading stocks. You can buy a stock when it first listed, the initial public offering, such as the recent Alibaba IPO. More commonly one trades the secondary market. This is the stock market where shares are bought and sold by the millions every day.
Predicting Prices and Making Money Trading Stocks
The eventual price of a stock is determined by fundamentals. These are the earnings of the company, its degree of debt or solvency, its prospects and the current price as compared to expected price in the next days, weeks, months and years. Does the company control its market sector? Has it skimped on R&D to the extent that competitors will steal their business?
The day by day and minute by minute price of stock is determined by what the market thinks at the moment. This is commonly called market sentiment. The stock has been going up and people are still buying because market sentiment is positive, for example. Reading the momentary and short lived ups and downs of the market is called technical analysis. The basic belief is that the past predicts the future. The market immediately corrects for changes in fundamentals and one can make money by reading statistically reliable trading signals.
Watch out for Stock Trading Basics II next week.
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