Note: This article is part of a four-part introductory series on understanding equities, bonds, options, and foreign exchange markets.
As schools nationwide begin to fill with eager minds (and eager bodies), now is a good time to teach the basics of investing to students looking to hit the ground running at their respective business clubs or classes. So with that, we at Bulls & Bears Press are rolling out a four-part introductory series covering the underlying basis of several major asset classes, including equities, bonds, options, and currencies. These articles will not teach you to make millions, but rather provide a fundamental understanding of what drives these assets so that with the right training and work, you can make millions.
By far one of the most popular vehicles of investing, stocks (also referred to as equities) have gained tremendous popularity with the advent of electronic trading and the tech-bubble of the late 90s. With daily upswings over 100 points in both the Dow Jones Industrial Index and the NASDAQ, the question was not what to invest in, but rather how much should be allotted to this dotcom company or that tech company. Stocks became some magical way to transform nothing into wealth overnight, without fully understanding how they work. While the ensuing crash scared off many new and would be investors, stocks were forever on mainstream America's radar from that moment.
Stocks, at the most fundamental level, simply signify partial ownership in a company, and therefore ownership in the company's assets and profits. Some stocks distribute the profits in the form of dividends, which are payments to the company's owners (stockholders). Others believe that the money is better off reinvested to produce further profits in the future. This is why people refer to a stock as equity, since like home equity, it represents ownership. Each piece of stock, denominated in shares, controls one vote to elect the board of directors at a company. But while voting power is nice, ultimately the most important reason to own stock for the common investor is the claim on assets and earnings.
However, stock prices fluctuate everyday due to many factors, like how a company performed or if it increased its dividend payments, that all boil down to supply and demand on the market. If a company releases positive news, then demand increases as people rush to increase their claim of the assets and profits which leads to higher prices. Conversely, negative news would lead people to sell their claim and a drop in the price. Also factored into stock prices are the sentiment, or feelings, of the investors. If a majority of the investors expect growth in the company, they would put their claims in before the price rises, leading an increase in demand and therefore a self-fulling price increase. This is why stock prices don't just reflect the current value of the company, but also future expectations of growth.
Pricing a stock is one of the hardest tasks to do, with some believing that there is no method for truly discovering stock prices beforehand. But as investors try, they develop numerous ratios, variables, and indicators like price/earnings, PEG, Fibonacci retracements, and moving average convergence divergence. As to their effects, some swear by them and some swear they are for fools.
As for what is with the farm animal references? A bull market is one in which everything is going well. Companies are flourishing, the economy is growing healthily, and stock prices are rising. In these markets, making money is easy as almost every stock is rising. A person with an optimistic outlook is often called a “Bull.” On the opposite end is a bear market where it seems like everything is crashing and the world is ending, much like what we have seen in the recently. Traders can make money by “short-selling,” or borrowing shares to sell and then returning the shares at a lower price.
Some less common animals are chickens and pigs. Chickens are afraid to invest in anything and instead stash their money in banks or under the mattress. Pigs invest with their emotions, looking to score that big home-run without doing their homework. It is often from pigs that others profit from.
By constantly researching and learning about stocks, you can greatly improve your odds in picking winners. But too many people come in thinking they can pick popular companies on tips from friends and make boatloads of money. Remember:
“Bulls make money, bears make money, pigs get slaughtered!”
