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Now that you have a clear understanding of "The Need to Invest" and "The IPO Markets" , we are now set to explore the stock markets a step further. Once a company becomes publicly traded, the company is obligated to disclose all information related to the company to the public. The shares of a public limited company are traded on the stock exchanges daily. There are a few reasons why market participants trade stocks. We will explore some of these reasons in this chapter.

At the end of this module, you will replay the interactive game on The Need to Invest . This time , wait until the game reaches year 3 (Index Funds) and year 4 (Stock Market) before buying and selling any securities. The goal is to focus solely on buying Index Funds and Stocks. Don't worry about losing simulated money; we just want you to get a clear picture of how the index and stock market move, and how poorly time trades can lead to unexpected losses.

Understanding Stocks

Stocks, also known as shares or equities, represent ownership in a company. When you buy a stock, you're essentially buying a small piece of that company. For example, imagine a local lemonade stand. If you buy one share of the lemonade stand company, you become a partial owner of the business. This means you have a say in important decisions, such as what flavors of lemonade to sell or whether to expand the business. Stocks are typically bought and sold on stock exchanges, which serve as marketplaces for investors to trade securities.

Let's look at a recent real-world example: Apple's stock buyback announcement in May, 2024. This news essentially signaled that Apple's management believes their stock price is undervalued. They're using company cash to buy back shares, which can decrease the total number of shares outstanding and potentially increase the value of remaining shares (think of it as a smaller pie being divided among the same number of people, resulting in bigger slices).

This announcement can attract two different types of investors:

Investor A: This investor might believe the buyback is a positive sign and see the stock price potentially rising further.  They would likely be a buyer of Apple stock after the announcement.

Investor B:  This investor might be skeptical of the buyback's long-term impact and believe the stock price is already fairly valued. They might choose to be a seller of Apple stock after the announcement.

Therefore, at the same price point after the buyback announcement, Investor A would be buying Apple shares, while Investor B might be selling them, reflecting their differing viewpoints on the company's future.

This is just one example, and many factors influence stock prices. But it showcases how supply and demand from buyers and sellers with varying perspectives drive market movements.

The key takeaway here is that a stock represents a piece of ownership in a company. When you buy a stock, you're essentially buying a tiny slice of that company. The more shares you own, the larger your ownership stake becomes. Interestingly, while you might buy a stock for a specific reason, another investor might sell for entirely different reasons. This interplay of supply and demand from buyers and sellers with varying perspectives is what leads to price fluctuations in the market.

Types of Stocks

There are two main types of stocks: Common stocks and Preferred stocks. Common stocks are like the basic building blocks of the stock market. They represent ownership in a company and usually come with voting rights at shareholder meetings. In our lemonade stand example, owning common stock would give you the right to vote on important decisions, like whether to hire a new employee. On the other hand, preferred stocks are a bit different. They often don't come with voting rights, but they usually have priority over common stocks when it comes to receiving dividends (profits distributed to shareholders) or assets if the company goes bankrupt.

For instance, imagine you own preferred stock in a fictional company called XYZ Corp. If XYZ Corp decides to distribute dividends to its shareholders, preferred shareholders, like yourself, would be paid before common shareholders. However, you might not have voting rights in the company's shareholder meetings.

Stock Movement

Let’s explore the dynamics of stock movement with a hypothetical example involving a well-known tech company, which we’ll call TechZ.

Imagine it’s 8:30 AM CDT and TechZ is trading at $300 per share. Suddenly, the company announces the appointment of a new CEO, touted to propel the company to new heights. This kind of positive news typically leads to an increase in the stock price as investors rush to buy shares, anticipating future growth.

Consider this sequence of events:

This table shows how the stock price can jump $16 in just 5 minutes due to a bullish market sentiment. In this case, the price increase is driven by the resolution of a leadership issue and the anticipation of the new CEO’s positive impact on the company.

Now, let’s fast forward to 12:30 PM the same day. The US Govt. announces a 15% reduction in IT budgets, which could negatively impact the industry. Assuming TechZ’s stock is now at $316, this news might lead to a mixed reaction. While the earlier positive news about the CEO might provide some support, a potential 15% revenue decline is significant, and the stock is likely to trade lower.

If you were considering a trade based on this new information, it might be prudent to sell TechZ shares. Moreover, this industry-wide news would likely put selling pressure on all IT stocks, not just TechZ.

Stock prices are influenced by news and events, whether related to a specific company, the industry, or the economy at large. For instance, the election of a new pro-business president might lift the entire stock market.

What if there’s no news? Stock prices can still fluctuate based on supply and demand. A well-known company like TechZ might see constant price movement due to ongoing trading activity, while a lesser-known company might not attract as much attention and thus experience minimal price changes.

When it comes to trading stocks, the process is streamlined to ensure smooth transactions. If you decide to buy 200 shares of TechZ at $316, you’d log into your trading account, place the order, and the exchange would match your buy order with sellers. Once the trade is executed, the shares are transferred to your investment account, making you a part-owner of TechZ.

Stock Market Indices

The stock market indices are also known as Index Funds. Indices are essentially summaries of the stock market’s performance. They provide a quick glimpse into how a particular segment of the market is faring. For instance, the S&P 500 is a popular index that tracks the stock performance of 500 large companies listed on stock exchanges in the United States. It’s like a big scoreboard that shows how these companies are collectively performing. If the score goes up, it suggests that the companies are doing well overall, and the economy might be in good shape. If it drops, it could indicate that the companies, and perhaps the economy, are facing challenges.

Let’s say you have a garden with 500 different types of flowers. The S&P 500 is like a measure of the health of your garden. If most flowers are blooming, your garden is thriving, much like the stock market when the index is up. But if the flowers start wilting, it’s a sign that your garden needs attention, just as a falling index may signal economic troubles.

Top Sectors in the S&P 500

The Dow Jones Industrial Average (DJIA) is another key index, but it’s more like a snapshot of 30 industry leaders in the U.S. stock market. You can think of the DJIA as a highlight reel of the biggest and most influential companies. If this highlight reel shows these companies scoring big, it’s a good sign for the market. But if they’re missing their shots, the market might be in for a rough time.

By keeping an eye on these indices, investors can get a sense of the market’s direction. They’re like the dashboard of a car, where each gauge helps the driver understand what’s happening under the hood. If the gauges show that everything is running smoothly, the driver can relax and keep driving. But if a warning light comes on, it’s a signal that something needs to be checked. Similarly, investors use indices to decide when to speed up their investments or when to pump the brakes.

Stock Exchanges

Stock exchanges are like big marketplaces where stocks are bought and sold. The New York Stock Exchange (NYSE) and the NASDAQ are two examples. Imagine them as bustling farmers' markets, but instead of selling fruits and vegetables, they're trading stocks of different companies. Each exchange has its own set of rules and requirements for companies that want to be listed (or sold) there.

For example, the NYSE is known for its iconic trading floor, where traders used to shout and signal their orders. It's one of the oldest and largest stock exchanges in the world, with many well-established companies listed on its platform. In contrast, the NASDAQ is entirely electronic, meaning trades are made using computers. It's known for listing many technology companies like Apple and Google. Each exchange has its pros and cons, and investors should consider these factors when choosing where to buy and sell stocks.

Buying Stock

Buying stock is like buying a piece of a company. It's as simple as going to a stockbroker (either online or in person) and placing an order. Let's say you want to buy a share of your favorite toy company. You'd tell your broker how many shares you want to buy and at what price. Once the order is placed, your broker will try to find someone willing to sell you the shares. When they do, congratulations! You're now a proud owner of a piece of that company.

Selling Stock

Selling stock is like saying goodbye to your ownership in a company. It's as easy as placing an order to sell your shares through your broker. Let's say you bought a share of a video game company a while ago, and now you want to sell it to buy shares of another company. You'd tell your broker how many shares you want to sell and at what price. Once the order is placed, your broker will try to find someone willing to buy your shares. When they do, you've successfully sold your stock.

Fractional Shares

Fractional shares allow investors to buy a portion of a stock instead of a whole share. Imagine you want to buy a share of a company, but the price is too high for just one share. With fractional shares, you can invest whatever amount you have, even if it's just a fraction of a share.

For example, if a share of your favorite tech company costs $1,000, but you only have $100 to invest, you can buy 0.1 (or 10%) of a share. Fractional shares make investing more accessible to people with smaller budgets and allow investors to diversify their portfolios more easily.

Stock Split

A stock split is like cutting a pie into smaller slices. When a company's stock price gets too high, it might decide to split its shares into smaller pieces. For example, if a company's stock is trading at $1,000 per share and it decides to do a 2-for-1 stock split, each shareholder will receive two shares for every one share they own. After the split, the price per share will be halved to $500, but shareholders will have twice as many shares as before.

Stock splits are usually done to make shares more affordable for investors and increase liquidity in the market. They don't change the overall value of an investor's holdings, but they can attract more investors to the stock.

How To Read a Stock Quote

You've done a great job getting to this stage! By now, you should have a grasp of stocks and what they entail in the simplest terms. Your next step is to understand how to read stock quotes, as this is something you'll encounter every day as a stock investor or trader.

Let's take a look at Starbucks Corporation (SBUX) on Yahoo Finance here and see how it looks.

If it's your first time opening a stock quote, you might be wondering what the heck is going on here. This section is designed to help you understand each term on the quote dashboard and its description. If you are a visual person, the image below is sufficient for you to understand how to read a stock quote; otherwise, you can read the definitions below.

Breakdown of what each component of a stock quote represents:

Ticker Symbol (XXX): This is a unique series of letters representing a specific publicly traded company. It's used for easy identification in stock exchanges.

Last Price ($XXX.XX): This is the most recent price at which the stock was traded. It indicates the value investors are currently willing to pay for one share of the company.

Change ($XX.XX): This shows the difference between the current trading price and the previous day's closing price. It's a measure of the stock's performance over a short period.

% Change (%X.XX): This is the percentage change in price from the previous day's closing price to the current trading price. It provides a quick overview of the stock's performance relative to its previous value.

Bid ($XXX.XX): The bid price is the highest price a buyer is willing to pay for a stock at a given moment. It represents the demand for the stock at that price point.

Ask ($XXX.XX): The ask price is the lowest price a seller is willing to accept for a stock at a given moment. It represents the supply of the stock at that price point.

Day's Range ($XX.XX - $XX.XX): This shows the range of prices within which the stock has traded during the current trading day.

52 Week Range ($XX.XX - $XX.XX): This indicates the highest and lowest prices at which the stock has traded over the past 52 weeks.

Volume (XX,XXX,XXX): This represents the total number of shares of the company's stock that have been traded during the current trading day.

Average Volume (XX,XXX,XXX): This is the average number of shares traded daily over a specific period, usually 30 or 90 days.

Market Cap (XXX.XX B): Market capitalization is the total value of a company's outstanding shares of stock. It's calculated by multiplying the current stock price by the total number of outstanding shares.

Beta (X.XX): Beta measures the volatility of a stock compared to the overall market. A beta greater than 1 indicates higher volatility, while a beta less than 1 indicates lower volatility.

One last thing before we play the game: where do you fit in, investing or trading?

In the financial markets, each participant has their own approach, which evolves with experience and exposure to different market conditions. This approach is also shaped by one’s risk tolerance. Generally, participants fall into two categories: traders or investors.

Traders are individuals who identify opportunities in the market and initiate trades with the goal of exiting for a profit as soon as possible. They tend to have a short-term outlook and are vigilant during trading hours, constantly assessing opportunities based on potential risks and rewards. Traders are flexible and can take positions that anticipate either an increase (going long) or a decrease (going short) in a stock’s price.

Here are some types of traders:

Day Trader: This trader starts and ends their trades within the same trading day, avoiding holding positions overnight to minimize risk. For instance, they might buy 100 shares of Apple at $150 at market open and sell them at $152 before the close, netting a profit for the day.

Scalper: A subset of day trading, scalpers trade large volumes for short durations to capture small price changes. For example, a scalper might buy 10,000 shares of Apple at $150 and sell them minutes later at $150.10, making a quick profit.

Swing Trader: Swing traders hold positions for longer periods, ranging from several days to weeks, aiming to profit from price ‘swings.’ They might buy shares of Tesla at $600 and sell them a week later at $620.

Some renowned traders include George Soros, Ed Seykota, and Paul Tudor Jones.

Investors, on the other hand, purchase stocks with the expectation of significant long-term appreciation. They are patient and willing to wait for their investments to mature, often holding for years.

Investors can be:

Growth Investors: They seek companies poised for substantial growth due to industry trends or macroeconomic factors. An American example would be investing in tech giants like Google or Amazon in the early 2000s, which have since experienced exponential growth.

Value Investors: These investors look for undervalued companies that may be temporarily out of favor but have solid fundamentals. A recent example is buying quality stocks during market dips, such as the downturn in March 2020, and benefiting from the subsequent recovery.

By understanding these roles, you can better identify where you fit in the market landscape and develop a strategy that aligns with your financial goals and risk appetite.

Now let's play the game!  Wait until the game reaches year 3 (Index Funds) and year 4 (Stock Market) before buying or selling any securities. Once you reach these years, focus on buying only index funds and stocks.