The Stock Market 101: Part 2
What Makes Share Price Move: Demand and Supply Basics
The prices of the shares listed on the major exchanges are changing constantly during market open hours. They are moved by the orders from individual traders through to large banks and institutions. The basic concept that determines these price fluctuations is that of demand and supply. To put it simply, if more people want to buy stock XYZ than sell it price will rise, conversely if more people want to sell the same stock than want to buy it price will fall. This is a pretty basic interpretation and it fails to consider the factors that contribute to these buying and selling decisions. Fundamental Traders Fundamental traders are people who make their decisions based on market, sector and stock specific news. For example, in an expanding economy, a bullish sector and with an excellent earnings report from a specific stock a fundamental investor will probably choose to open a long position or add to the position he/ she already has. This exceptionally likely if the current price trend is up; as the old adage goes: the trend is your friend. The fundamental analyst would see this positive news as a sure sign that price will move higher. After all this news is sure to increase the demand for the stock and decrease the supply. The problem with fundamental analysis in its most basic form is that it doesn’t take trader psychology into consideration. What we mean by this is the impact that fear and greed will have on price cannot be measured. An example of this would be a highflying stock, such as one of the Internet stocks during the boom in the late 1990s. All fundamental reasoning for prices to reach as high as they did went out of the window. Share prices were over valuing companies who failed to make any profit. Price was in fact being driven higher by greed. Everyone wanted to invest in these stocks and make a fortune. As soon as the price stopped rising and began to fall the human emotion of fear kicked in sending share prices into a rapid decent. Technical Traders Strictly technical traders completely ignore the fundamentals and stick to spotting price patterns. Technical traders argue that price patterns mimic the psychology of the market’s participants. By spotting patterns that have occurred multiple times throughout charting history a technical trader will aim to put the odds of being able to pick a profitable position in his/ her favour. Of course no technical patter is 100% guaranteed to repeat itself every time and technical traders often find their analysis undone by unexpected fundamental reports such as earnings or legislation releases. Combining the Two Most successful traders will tell you that they have found a happy medium between trading both fundamentals and technicals. This means that they are aware of company earnings and the business environment but wait for key technical levels before making their trades. Professional traders always have a clear, definable method for their entry and their exit, stick to their trading rules religiously and ignore their emotions. It is this discipline and consistency that breads success. Always keep in mind that everyone has slightly differing views on where a particular stock is headed, how quickly and how far it will go. If everyone had the same idea then the market wouldn’t exist at all. That is why it is so important for you to learn to trust your judgement. A Company’s True Value While reading through a list of quotes in your daily news paper or online you may be forgiven for thinking that the companies with the highest priced shares are worth more than those with a lower stock price. This is not the case. A company’s current market value is calculated in terms of market capitalization. This is calculated by multiplying the number of outstanding shares by the current price per share. A good example of this is as follows: At the time of writing Google (GOOG) has a share price of $375.39. Therefore it will cost you $375.39 to buy one share in Google. At the same time Microsoft (MSFT) has a share price of $24.21, much lower. So which company has the greatest value? The answer, maybe surprisingly (when looking at the share price anyway!) is MSFT. Microsoft has a market capitalization of $243.6 Billion compared to Google’s $113.78 Billion. The reason for this is of course the number of shares in issue. To put this into perspective the average daily volume (number of shares changing hands every day) for Google is almost 7 million compared to more than 82 million for Microsoft. Keeping in Touch With The Market
We don’t want to go into too much detail about how to choose the shares you wish to invest in but here are a few brief pointers: Choose a company you have had many experiences with, possibly even on a daily basis. If you love their customer service and efficiency the chances are others will too. Do your research. The Internet is an invaluable source of information. Most companies will often have an ‘investor relations’ page keeping you up to date will past, present and future performance and news. Take your time. Don’t rush into anything, the market was there yesterday and it will be here tomorrow. Make sure you understand the ins and outs of what you are doing and feel confident in your trading or investment plan. We have already written about the power of the Internet when researching your potential investments but it is also an excellent means of keeping track of the day-to-day price movements. You can log on to http://www.NASDAQ.com http://www.nyse.com or http://finance.yahoo.com/ where you are provided with slightly delayed market data and news releases. This is by no means sufficient for the active day trader but it is enough information to keep most people up to date. Trading Vs Investing
The difference between trading and investing is quite a large one. An investor is someone who buys shares in a company with the intention of holding onto them for a period of years (all things being well). Therefore an investor is relatively uninterested in daily price fluctuations and will be paying much more attention to press releases, earnings reports and news items concerning the companies they have invested in. On the other hand a trader can open and close a position in a matter of seconds or hold on for several months. A very active trader (seconds, minutes, hours) is known as a day trader while the less active (days, weeks, months) are swing traders. Investing and trading can both be highly profitable pursuits but you should consider several factors before deciding which path to follow. For example, if daily price fluctuations make you nervous you should probably stay away from day trading and move towards investment or longer term swing trading. Day trading is for those who can stay detached from their emotions and want to make trading a full-time job. Choosing a Broker There are two different types of broker that will enable you to buy and sell shares, full-service and discount. Full-Service: The first brokerages on the scene were mainly full service. These brokerages can actually manage your account for you and recommend certain investments. The fact of the matter is that these brokerages are very expensive and you lose control over your own investments. Discount: Don’t be put off by the name, discount doesn’t mean ‘cheap and nasty’. Discount brokers exploded into the market place with the arrival of the Internet. Rather than offer you advice and mange your account, you are free to do this via an online trading platform. Your discount broker makes their money by charging you commission costs for any trades you execute. The rate of these costs depends on how often you place trades. When you come to open your first brokerage account you must do your due diligence so you avoid any unnecessary costs or wasted time. By the time you come to open your first account you will probably have a good idea of how active you will be and therefore the commission costs you should look to pay. Internet forums are an excellent source of independent reviews and experiences that will help you find the best brokers in a highly competitive market. The difference between trading and investing is quite a large one. An investor is someone who buys shares in a company with the intention of holding onto them for a period of years (all things being well). Therefore an investor is relatively uninterested in daily price fluctuations and will be paying much more attention to press releases, earnings reports and news items concerning the companies they have invested in. On the other hand a trader can open and close a position in a matter of seconds or hold on for several months. A very active trader (seconds, minutes, hours) is known as a day trader while the less active (days, weeks, months) are swing traders. Investing and trading can both be highly profitable pursuits but you should consider several factors before deciding which path to follow. For example, if daily price fluctuations make you nervous you should probably stay away from day trading and move towards investment or longer term swing trading. Day trading is for those who can stay detached from their emotions and want to make trading a full-time job Conclusion
This is what we have learned over the course of this tutorial: Ignore the hearsay – Don’t become involved in the ‘heard mentality’ of the general public. Take your time to learn about the inner workings of the stock market and develop your own trading plan. Stock, share, equity – All of these terms mean the same thing and ownership of them entitles you to voting rights and dividend payments. Why do we have stocks? – Stocks are issued to raise money for a business, this method is known as equity financing. Preferred or common stock? – Preferred and common stocks have different characteristics. Most of the investment decisions you come to make will involve common stock. The Exchange – There are two major types of exchange, listed and over the counter. Supply and demand make the market move – Supply and demand are governed by fundamentals, technical and trader psychology. A company’s true value – Market capitalization is the true value of a company and not share price. Keeping in touch – You can use the Internet to great effect when you wish to research and keep in touch with your investments. Trading Vs. investing – The type of market participant you become depends heavily on your spare time and your emotional attachment. Choosing a broker – Whether you want to invest or day/ swing trade will determine the broker you want to use. Remember due diligence is key. David Thorpe is a senior contributor for www.passion-trading.com a free educational resource centre for traders and investors. The goal of the site is to stimulate the minds of its users, enabling them to achieve a greater understanding of the art of trading, thus helping them to become more profitable. |
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