Crash Course in Stocks

Are you a newbie thinking of riding on the latest waves of bulls in the global stock market? Don't rush into it! It's hard enough to see your neighbors profiting from the up-cycle in the markets, you don't want to make it harder by going in at the peak only to lose money when the market tumbles. Sure, investment is one way to increase your wealth passively, but it is not the only way. Make sure you do your research before going into investment.

There are some basic things to read about in the world of investments.

Basics of a Stock

A stock, put simply, is a certificate of ownership of a company that issued it. Companies normally issue stocks to raise capital in order to fund their expanding business operations, in return for bigger profits. When the stocks are issued, investors buy them and then legally become a small owner of the company. The money then goes to the company for their operations.

The stocks once owned by the investors can then be traded on the stock exchange, a glorified market place where these certificates change hands from an owner to another. The price of the stock, determined by the seller and buyer, is what you see scroll on the ticker in the stock market.

Dividends

When you own the stock of a company, the directors can sometimes decide to dish out dividends (which are a portion of the company's earnings over a period) to investors as a measure of good will, or as a message to all to say that "I'm doing very well!" Needless to say, dividends issued by the company whose stock you own drives up your returns, and makes many investors happy.

Fees and Taxes

When investing, you can be sure that your money will go through many hands before it gets to the company or to the seller who sold his stocks to you. Regardless of the value of the service added along to way, you are bound to incur some fees in terms of commissions, sales charges, blah blah blah. These fees will eat into your final profit, because they increase the cost of your stock. Some of these fees are subject to a minimum so be sure on what the fees are before purchasing your stock. Otherwise you may end up paying too much fees for a small amount that you purchased.

When trading stocks on exchanges from certain countries, your gains over the original price of the stock can be taxed, thus reducing your overall return. Dividends when issued to you can also be taxed. Clearly, you will need to know the tax structure before you make the decision to purchase the stock.




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Factors Affecting Stock Price

The price of stock is generally affected by company financials, that is, how well the company is perceived to perform in the future. That means the price on the stock is what investors' perception or prediction of the company's profitability.

The company's profitability can then, in turn, be affected by:
1. Inflation: Cost of raw materials/shipping rise rises and eats into profits.
2. War/Bad News: Affect consumers ability to spend, which lowers revenue.
3. Competition: Cost increase to provide additional value add, or revenue lowers to compete.
4. Mergers/Acquisitions: Reduce competition, consolidate operations to reduce cost.
5. Dividends: Issue of dividends increases cost to company.
6. Interest Rates: Higher interest rates also drives up borrowing cost for companies, leading to lower profits.

But there are other factors that can affect stock prices are not directly related to company financials, but to investor supply-and-demand.
1. Interest Rates: Higher interest rates for increases savings rates and bonds yields, means less demand for risky stocks (or more demand for cheaper stocks so they can get higher return), so stock price falls.
2. Expectation of Dividends: Drives demand, and this increases stock prices.
3. Regulatory: Government intervention to impose regulatory restrictions may affect investor returns, driving prices up or down accordingly.
4. Large Investors: Be it rich individuals or large institutions, they can drive the price of a stock by virtue of the percentage of shares they own.

At the end of the day (no pun intended), a stock price can only move in two directions: up or down. But the factors that affect its direction can be considered, in the mathematical sense, random. This is because the investor does not know a priori, some of the factors that will affect the price until it happens.

Conclusion

The explanation to how stock trading works is nothing complex. But the picking of the right stock, deciding when to buy, when to sell, is what's extremely difficult.

Tonnes and tonnes of material have been written on selection strategies, including suggestions from the academic community. There are strategies that employ technical analysis of charts to predict the next peak / trough. There are those that use fundamental analysis to determine the future profitability of a company. There are even those who use the movement of the planets, funny graphs and what-nots to plot the next market downturn! (But don't believe those please).

If and when I next write about investment strategies, I would love to talk about the lazy investor's approach to investing: using Mutual Funds and Index Funds. In the meantime, do read up on some of the techniques used by traders and investors.

Technical Analysis of the Financial Markets
Technical Analysis of Stock Trends, Ninth Edition
The Little Book of Common Sense Investing