In this article, I will walk you through the basics of Stock investing and trading.
First, let me give you a brief outline of stocks and shares. In simple words, Stock is essentially a representation of an ownership share in a company. They represent a defined claim on company’s assets and earnings. So, if you are purchasing a stock, you’re basically purchasing a minuscule part of that company, called a share.
So, when you have purchased a company’s stock. You are essentially betting on the prospect that the company’s value will go up. This is because when a company’s value goes up, value of their stocks also goes up. I have discussed more about stocks later in the article, so stay tuned for that.
Now, let’s understand the difference between trading and investing.
Trading and investing both are an art of making money from money. Trading and Investing are two different ways to seek profit from a company’s stock. Stock trading is all about buying and selling stocks for short term gains. Or you can say buying and selling stocks for quick money. On the other hand, stock investing is buying stocks for long term gains, generally for years or even decades.
First, let’s discuss stock trading, stock traders are essentially those who buys and sells stocks to capitalise on daily fluctuations. And keep a sharp eye on the stock market. A prime example of stock trader would be someone like George Soros or John Paulson. Both haves their net worth in billions. These traders seek short term profits by jumping in and out of stocks in minutes or days or even weeks. These traders are further divided into two categories: Day traders and Swing traders. Now, let’s understand the key differences between these.
1. Day traders
• As you may have guessed by the name. Day traders are those who make a number of trades in one single day. They seek profit out of price discrepancies based on their sophisticated analysis of stocks. These traders possess an exceptional technical and fundamental knowledge of charting systems.
• Day trading is not for everyone because it is very tough and stressful as it requires watching multiple screens. And spotting trade opportunities and quickly capitalising on them.
• Day trading requires making quick decisions and capitalising on information they just saw on their computers. Day traders generally have to be full time traders. Because they can not afford to lose a single trade opportunity. While being busy working in their conventional job.
• At the end of the day, when they shut down their computers. That means they have exited all trading positions. And now they don’t have to worry about any change that impacts the market.
• Day trading is a high risk high reward kind of thing. The potential of making huge profits comes with a potential of huge loss. That is why this is not for every individual. Even the skilled individuals can face losses in day trading but on the overall chart. They also have the potential to convert all their loss into profit in no time.
2. Swing traders
• As the name suggests swing trading is identifying swings in stocks and not replying on instant decisions. These traders are focused more on the bigger picture, so they don’t have to monitor the charting systems every day.
• These trades can provide results in few days or few weeks. Due to this a swing trader does not have to stick to their computer screen all day. One major benefit of being a swing trader is that this is not a full time job. One can easily do this trading as a part-time to their conventional job.
• Even though this involves holding positions for days to weeks. They also run a substantial risk of facing a loss. However, this risk of losing is comparatively less than compared to that of day trading.
Time is the chief difference between trading and investing. Investing is seeking long term benefits and gradually making money, in contrast to trading. Warren Buffet, the legendary investor defines investing as “ process of laying out money now to receive more money in the future”.
The goal of investing in stock market is to buy a stock. And holding it for long term and getting dividends on a regular basis. Dividends are the distribution of a company’s profit to its shareholders.
Stock investment takes advantage of the growing economy because when the economy grows, so do corporate earnings. This is because economic growth promotes jobs, which creates more earnings and hence more sales.
Investing in stocks is a way to stay ahead of inflation. As we all know, prices of goods and services rise over time and hence the value of money decreases. This is why, it is not advisable to hold and save your money at home. Instead you should invest it otherwise value of your money is decreasing and you are getting poorer. So, investing money in Stocks is a great way to stay ahead of inflation.
By now, you must have heard the word ‘Stock’ quite many times. So, let’s get in the details of a stock.
Definition of ‘Stock’
A stock is an investment security which represents an ownership share in a company. From the perspective of a company, stocks are a way to generate money to grow and expand their business.
When you buy a stock of a company. You are basically buying a small fraction of that company called a ‘share’. A stock is essentially a part of company’s assets and earnings. So, if you have stock of a company it represents a claim on company’s assets and earnings.
If you know even little about share market, you must have heard the word Shareholders. They are investors who own the stocks of a particular company and hence they have a share in company’s profits.
Value of a company’s stock fluctuates regularly and sometimes go really high and sometimes really low. So, investors buy stocks in the companies which are expected to grow and perform well in the upcoming years.
Working of Stocks
As I mentioned earlier, stocks are issued by companies to maintain and grow their business. People who purchase these stocks are called shareholders, these people now own an owner of the issuing company. This ownership is determined by the number of shares a shareholder owns. For example- If a company issues 1,000 (assume) shares of stock and someone buy 200 shares. That person now have a claim on 20% of company’s assets and earnings.
One thing is to be noted here that these claims are not on the company’s property; shareholders do not have the right to take a table or chair out of company just because they are shareholders. They hold a percentage of company’s shares not all of their assets.
For buying and selling of the stocks you need a Stockbroker. A stockbroker is a professional who is authorised by government to buy and sell stocks, they often work under a brokerage firm and sells and buys stocks on their behalf.
These stockbrokers charge a commission fee which depends on the firms. Luckily, due to the advent of technology and evolution of the internet, you can buy and sell stocks online and hence eliminate the headache of talking to a stockbroker. Although, these online apps and
websites also charge some commission just like a stockbroker they are much easy to deal with and you have more options as well.
The rights and claims a stock provides to the shareholder depends on the type of stock they own. Primarily, there are two types of stocks: Common stock and Preferred stock. Now, let’s discuss these in detail.
Common and Preferred Stock
The prime difference between Common and Preferred stock is that common stocks provide shareholders Voting rights in contrast to Preferred stocks which does not provide any voting rights whatsoever.
1. Common stock:
• When you hear someone saying they have bought stocks of a company, they are probably referring to common stocks. In fact, a company issues more common stocks than preferred stocks.
• These represent a claim on dividends and confer voting rights. Your voting power is directly proportional to the number of stocks you own. These voting rights are used to appoint the Board of directors and to decide corporate policies which will ultimately decide the future of company.
- Value of common shares is determined by the demand and supply of market participants.
- In the case of a bankruptcy, common stock holders will be the last one in line to get paid. Creditors, bondholders and preferred stockholder will be paid first and in the end common stockholders will be paid.
- Common shares can not be converted in preferred shares.
2. Preferred stock:
- These do not offer their holders any voting rights. So, in case of voting board of directors and corporate policies, preferred stockholders have no voice and hence no hand in the future of company.
- Preferred stockholders are given fixed and calculated dividends.
- In case of interest rates increasing, the value of preferred stocks atrophies and vice versa.
- In case of a bankruptcy, when the assets of the company will be liquidated, these have a priority over common stockholders. This means preferred stockholders will be paid before the common stockholders.
- Preferred shares can be converted to a fixed number of common shares, whereas, common shares have no such benefit whatsoever.
Before explaining Stock exchange, this is to be noted that stock exchange and stock market are two different words which can be used interchangeably, but stock exchange is a subset of the stock market.
Stock exchange is a platform where buyers and sellers come together to trade stocks, bonds, commodities and other financial equipment. However, only those companies who are listed in a stock exchange are allowed to trade in it.
There are numerous stock exchanges across the globe.
The NASDAQ, New York stock exchange (NYSE), London stock exchange (LSE), and Bombay stock exchange (BSE) are examples of the biggest stock exchanges. All these major stock exchanges are now operated electronically.
For companies to get listed on a stock exchange, they need to meet specific standards, which can vary depending on the stock exchange. But, getting listed on a stock exchange provides numerous benefits to the companies. Let’s discuss those benefits in detail.
Benefits of Stock exchange listing
- Prestige factor– Getting listed on a stock exchange brings a certain level of prestige to the company. This is especially true for larger stock exchanges, being listed on them is a proud factor for companies.
- Increasing Capital– To avail capital, company issues their shares in the stock exchange market for shareholders. These shares when purchased by shareholders provide cheap capital to companies and companies can use this capital to operate and grow.
- Liquidity Maintenance– While getting the number of buyers and sellers for a particular financial security are out of control for the stock market, it ensures that whosoever is qualified and willing to trade gets instant access to place orders which should get executed at the fair price.
- Fair Price– The prices of listed securities are set by comparing the demand and supply. This ensures that investors who buy these securities are offered a fair price.
- Security and Validity of Transactions- With all participants being verified and remain compliment with the necessary rules and regulations, leaving no room for default by any of the parties.
- Regulations– High regulations on stock exchanges makes it less likely for traders to face counterparty risk.
- Enhanced Visibility– Going public increases company’s visibility and makes it available to the investors.
- Increased Accountability– Another benefit of being listed on stock exchange is having greater financial accountability. Every listed company on stock exchange is there because they meet the standards and hence a greater transparency.
For a company, being listed on a stock exchange can be costly and time consuming, but as you can determine by the above points, it is ultimately beneficial for them.