Demystifier: An ED Original where we take a complex topic but the content is written in such a way that it is knowledgeable and easy to comprehend at the same time.
I get it, we young’uns barely have the time to keep up with the latest release of iPhone let alone sit down to understand the basics of stock market and investing. That’s why in today’s segment of Everything Finance, we’ll be going over stock market 101 – your lazy guide to investing for millennials.
Obviously you’re not gonna go Warren Buffet just yet but it’s a good start nonetheless [insert any generic motivational quote by some dude we barely know].
In my previous post on Fixed Income Securities, including Zero Coupon Bond valuation and Money Market Instruments in Indian Financial System, we went over the different financial instruments and securities. We can now move onto the big boy league stuff.
Let’s get started with Stock Market 101
Stocks, or the more mature sounding, equities is basically what pops in your head as your “vanilla” trading tool. Stocks move up and down daily and can range from a few measly pennies to hundreds and thousands of dollars per share. Stocks/equity/shares basically represent ownership or stake in a company.
Why stocks in the first place?
Companies typically issue stocks to raise equity capital. Most big companies have their stocks listed on major exchanges around the globe. Smaller and other start-up companies usually have their stock held by the initial founders with some key investors. These would be private companies.
Not so tricky, right?
You newly founded GMO-Free, vegan, free range, better-than-Patanjali noodles business takes off and you want to inject more money to make it even better. You decide to offer a stake in your company in exchange of some $$$. To do so, you release shares. That’s the basic idea.
2 types of stocks
There are actually 2 different types of stocks or equities.
- Common stock is what is you are probably familiar with. The thing to remember with common stock is that it represents residual claims and limited liability. Residual claim implies that holders of common stock have the lowest priority on cash flows of the firm. Limited liability means common stock shareholders are not liable for any debt obligation that the company might have. If 2008 part 2 happens tomorrow, the most you stand to lose is your share in the company.
- Preferred stock is like the lovechild of common stock and bond in that it is a hybrid instrument and has elements of both stocks and bonds. With preferred stocks, shareholders get fixed dividend payments (like coupon bonds) but companies are under no obligation to actually pay any dividends. However, holders of preferred stock will get all the accumulated dividends when the company actually decides to pay dividends, before any common stock shareholders get paid.
There are also things like Penny Stocks (Wolf of Wall Street flashback anyone?). We won’t be going into that mostly because its trash and not worth really looking into in this series.
Hold up, what’s a dividend?
Alright, let’s go over some common lingo that you can also drop to impress people (read: ladies, am I right guys wink-wink)
- Volume: The number of shares of stock traded during a particular time period. Normally reported in daily trading volume.
- Bid Price: Price at which some Joe Schmuck wants to buy it at.
- Ask Price: Price at which some Joe Schmuck wants to sell at.
- Spread: The difference between the Bid and the Ask price.
- Volatility: Price movements associated with a particular stock. High volatility = high fluctuations in stocks. The more a stock moves up and down, the higher the volatility.
- Dividend: Portion of earnings that a company pays out to their shareholders. Remember, not all companies do this.
- PPS: Price Per Share, self-explanatory.
Got it, but why should I know all this?
To really understand how stocks actually change values and move up and down. Most of it beyond the scope of this lazy Stock Market 101 guide but the basic idea can still be understood.
Dust off your Econ 101 textbook and recall the principle behind every econ major’s wet dream – Supply and Demand.
The entire stock market can be thought of as a virtualization of this supply and demand. A high positive volume leads to upward movements in the stock prices, while a high negative volume does exactly the opposite.
A general advice is to ride out the volatility before taking on a position, that is, to wait for the volatility to level out in order to secure the best trade.
In this Stock Market 101 edition of Everything Finance, we looked into the ever so mysterious equity securities and the common jargon that gets used. You should now (hopefully) have a refined understanding of what stocks are. In the future editions, we’ll be looking at more financial instruments and maybe take a quick look into equity evaluation as well.
Let me know what you think about today’s post in the comment section below and share any hot insider tips you might have.
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