Investing in the Stock Market for the Individual Investor Over the past few years, the stock market has suffered substantial declines. Some short-term investors have lost a good bit of money. Many new stock market investors look at this and become very sceptical about getting in now. If you are considering investing in the stock market, it is very important that you understand how the markets work. The newcomer may become confused and overwhelmed by all of the financial and market data that they are bombarded with. The stock market is an everyday term used to describe a place where stocks in companies are bought and sold. Companies issue stock to finance new equipment, buy other companies, expand their business, introduce new products and services, etc. The investors who bought this stock now own a share of the company. If the company does well, the price of their stock will increase. If the company does not do well, the stock price will decrease. 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 in 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 a no-investment strategy. Before committing your hard-earned money to the stock market, it would behove 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 to sell it.
The 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 realised 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 to large fluctuations in stock prices. Originally, investing in the stock market was confined to the very wealthy. Now stock ownership has found its way to all sectors of 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 stocks is generally driven by short-term speculation about the company’s operations, products, services, etc. It is this speculation that influences an investor’s decision to buy or sell and at what price it is 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 are 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 decline and many companies are experiencing difficulties. Now 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 its 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 realise more profit. Investing in a bear market incurs the greatest possibility of losses because the trend is 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 to buy 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. Thesepeople relied on their broker to guide them and paid a hefty price incommissions and fees as a result. The advent of the Internet has led to a new class of brokerage houses. These companies offer online accounts through which you can log in and buy and sell stocks from any location with 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 securities
Blue chip stocks are large, well-established firms that have demonstrated good profitability and growth, a dividend payout, and quality products and services. 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-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 stocks 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 favoured by the speculative investor.
Income Stocks
Income stocks are stocks 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, but who is not interested in a gain in share price.
Value Stocks
Sometimes a company’s earnings and growth potential indicate that its share price should be higher than it is currently trading at. These 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 realise 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 emotions, panic, or greed. One of the most prominent investing strategies used by “investment pros” is market timing. This is an attempt to predict future prices based on 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. Risks 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 risk they present. For instance, internet stocks have demonstrated themselves to be much more risky than utility stocks. One risk is the stock’s 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 markets. “Don’t put all your eggs in the same basket,” as the saying goes. 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 made 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 only to 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 online orders in seconds. This new freedom has ushered in new masses of hopeful investors. Still, this is 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 a 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 market behaviour 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 daily gains. The self-proclaimed “experts” who sell books or run websites catering to day traders are likely to make the most money. 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.
