Finance 101: Understanding the Stock Market

Do you hear about the Dow Jones going up and down but have no idea what that means? Are you aware that a company’s stock price is low but don’t know why you should care? You’re not alone. Millions of Americans don’t understand one of this country’s most basic investment systems…the stock market. This will be a very basic explanation of the stock market to begin with. Understand there are many facets to the stock market – options, bonds, notes – and various ways to buy, sell and own these.

Terms and Definitions

Starting with some simple definitions, the concept of the stock market is based on the share. A stock is basically a piece of ownership of a company. A share is the unit of measure of the stock; you can one share or one million. A dividend is a payout of profits to the shareholders (owners) of the company. The ticker symbol is the two-four letter code that represents the company on the exchange. An exchange is where the trades take place, such as the New York Stock Exchange (NYSE). Today, many trades are done electronically, so an exchange be virtual or a physical place. In general, any trading vehicle such as a stock can be referred to as a security. I often say I was in securities trading because I dealt with stock, bonds, notes, options, and other specialty vehicles. I’m going to use Coca Cola Company as an example to explain this better. 

Quick Example

Coca Cola’s ticker symbol is KO and they trade on the NYSE. To buy one share of their stock today costs $38.18. In the “old school” days you had to buy stock in lots (groups) of 100 shares or $3,818. After someone figured out how to sell partial lots on the exchanges, this is no longer the case. For the sake of the example, let’s say you bought 100 shares. As of now they have about 4.4 billion shares outstanding (owned by investors). Your 100 shares gives you way less than 1% share ownership in the company, 0.000002% to be exact. This ownership entitles you to a 20-cent dividend. That seems silly, right? Why buy the stock if you get so little ownership in the company. Buying the stock isn’t for ownership in Coca Cola (for this example), it’s for the exponential growth of your investment.

What you want to have happen is for the stock price to go up, that’s where you make your money. Fast forward to one year later. Your 100 shares of KO are now at a price of $48.18, a $10 increase per share. You sell your 100 shares for $48.18 per share or $4818. You just made $1000 doing absolutely nothing. You will pay tax on that $1,000 profit also called a capital gain. Uncle Sam is generous if you were to lose $1000 you can claim that as a capital loss to offset your taxes. Maybe you heard about the capital gains tax in the news. Very wealthy people want this tax decreased. So should you! Take the $4818 and invest in another company, this time maybe you’ll make $2000. Buy low, sell high. Doing this over and over again is what creates wealth.

Market Performance

Back around to the Dow Jones Industrial Average (DJIA). This is an average of the top performing stocks. Another measure is the S&P 500 created by a company called Standard and Poors (S&P). They actually have all sorts of indexes or averages. The one we hear the most about are the DJIA and the S&P500. There is so much to tell you about these various measures. The reason we hear so much about them is that are indicators of how the market is doing. The DJIA and S&P 500 goes up means the companies are gaining in value and investors are feeling good about buying stocks. When it goes down, companies’ value is decreasing and people either aren’t investing or they’re selling. It’s much more complex than that, but it’s the basic idea.

At the end of the day, the stock market is a compilation of all of the opinions of the people who buy stock. And buying stock is simply making a bet that the company will increase in value. If you’ve been afraid to play the stock market, don’t be. New Black Chicks explore all sorts of ways to make their money grow. You can start small. It’s so incredibly easy to open a brokerage account. You can buy as little or as much as you like. You can pool your money in an investment club. The online brokerages such as E-Trade or Scottrade have people who can assist you with every step of the process. Just do a trade to get the fear out of the way.

Two tips:

1) Never bet more than you can afford to lose

2) Investing in the stock market is a long-term strategy (unless you become a day trader)

 

I’m just keeping it new.

One Thought to “Finance 101: Understanding the Stock Market”

  1. […] plan, does it have a wealth-building component? If not, go back to step two. Remember you want to multiply your money. If you get $50 you want to turn that into a […]

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