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A stock is a piece of paper (or electronic equivalent) that
represents ownership in a company. An investor opens an account with a
stock broker, and then buys a number of shares in a publicly traded company. Each share you own represents a certain percent ownership in a company. If a company has 1000 shares in total, and you buy 100 shares, then you own
10% of that company.
Most companies have millions of shares outstanding, even billions,
and the average investor owns about a hundred shares or so, which is an extremely
tiny percentage of a company.
The major goal of course is to invest in a company in which their earnings are
growing. When earnings are growing fast, most often the price of
that stock rises. You essentially own a small percent of a financial
"pie," and it's better to buy stock in a company in which that pie is getting
bigger and not smaller.
Stocks are traded, or bought and sold, on a stock market. A
stock market is a place where buyers and sellers meet electronically. A buyer makes an offer for a stock at a bid price, and a seller
offers to sell it at an ask price. When a buyer and seller meet at the same
price, then a transaction takes place. There are usually one to three
pennies difference between the bid and ask (be wary of stocks that have
large gaps in the bid and ask, as the exchange may be shimming). The New York Stock Exchange is mostly a human exchange, where a
specialist supervises all trades in a particular stock. The Nasdaq
is an electronic exchange, where computer programs match the most similar
bid and ask prices together to make trades. The Nasdaq uses human
market makers in smaller capitalized stocks, who actually possess an inventory of
some stocks to buy and sell, and thus the market is not completely
electronic.
Useful concepts about individual stocks include dilution, float, and
employee stock options. Dilution is when a company increases the
number of shares outstanding, but you still own your 100 shares or so. Thus, your piece of the total financial pie got smaller. Dilution
often occurs when a company buys another company and pays for it with
stock, or when companies have financial problems and have to sell stock
to raise cash (known as a secondary offering). Float is
the number of shares that regularly trade on a stock market. A company
with a small float has shares that are tightly controlled by management or
large institutions. Such companies have greater volatility. Supply and demand prevails, and if there are more buyers than sellers, such
a stock could go up very quickly (or down quickly if a large seller
appears). Employee Stock Options are now expensed and published each quarter. There are countless companies that essentially steal from their shareholders
by giving large stock awards to a small group of managers, and now this
information can be evaluated before investing in any company.
Stocks are generally classified as small capitalized (cap), mid cap, large
cap, and now mega-cap. In general, the smaller the
capitalization, the higher the volatility and risk (although large caps can
also be very volatile, due to good or bad news or market events).
Another concept is the impact of the stock market itself. There
is a saying, "when the tide comes in, all the boats rise." If the
market is in an up trend (bullish), then more stocks tend to go up. When the
market is going down (bearish), then more stocks tend to go down. A
book was written in the 1970s ("A Random Walk" I believe was the title), in
which someone through darts at a newspaper stock table, and that portfolio
outperformed a flat market during the next year. Individual investors
must study the entire market, and the economy, before seriously
investing.
Stocks can have capital gains or losses, and dividends. A capital gain or loss is when you sell a stock at a different price than
what you paid for it (either at a profit or loss). Dividends are
paid quarterly by many companies, as an incentive to get
people to invest in their stock. Please remember, such income
is usually taxable, and your accountant should advise you on making such
transactions.
Most importantly, small investors should avoid putting "all their eggs in one
basket," and possibly not even buy individual stocks.
Mutual Funds pool individual investors money together and buy many stocks, to
reduce risk. The stock market is very risky, and financial education and hiring a
professional Certified Financial Planner (CFP), will increase the likelihood
of making money in the stock market.
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