The stock market is the most well-known place to invest. It is fast paced. It is glamorous. Millions of dollars are made and lost every minute the market is open. It can be intimidating to get started, but once you get a grasp on how it works, you will understand why there is no reason for you to be afraid to invest in the stock market and get your fair share of the gains.
The History of the New York Stock Exchange
Stock investing and trading has been around for hundreds of years, but a formal stock market was only an idea of the late 1700s. The NYSE can be traced back to May 17, 1792. On that date, 24 stock brokers gathered under a tree outside of 68 Wall Street in New York and signed the Buttonwood Agreement (you can see an image of the documents here).
At that time, the modern Wall Street we think of today was a long way off. The original brokers of what was then called the New York Stock & Exchange Board bought and sold portions of companies from one another, without any auctioneers, and charged a .25% commission on each trade.
Over the last 200+ years, the market has transformed from one of person-to-person trades to a primarily electronic interchange. The 24 original brokers gave way to owners of 1366 coveted seats, which sold for up to $4 million in 2005. Today, traders can buy a floor trading license for $40,000 per year.
In 1995, the all-paper trading system began to accept electronic trades. Today, the majority of all trades are electronic. Starting in 2007, customers could enter their own orders electronically, via their broker, for instant electronic trades via the NYSE hybrid market.
In 2007, the NYSE merged with Euronext, an Amsterdam based exchange operating in Belgium, France, Netherlands, Portugal, and the UK, to create NYSE Euronext, now the largest stock exchange in the world.
What is Stock?
Simply put, stock is a small ownership in a publicly owned company. When companies wish to raise funds, they sell a portion of the company to investors. That ownership is represented by shares of stock.
A small, private company owned by two members of a family may not have formal shares of stock, though each family member would be considered to own half of the stock. Companies with more investors are likely to have more formal documents defining each party’s ownership.
As companies grow, their valuations generally increase. Each time a new investor puts money into the company, the two sides negotiate the value of the company and how much of the company will be sold to the new investor. This is best known for taking place with startup companies and venture capital firms, though many other types of investors exist.
Once a company hits a certain point, its owners may decide to hold an initial public offering (IPO) of the company’s shares. When this happens, any investor, large or small, can purchase shares of the company through an organized stock market like the NYSE or NASDAQ.
When a company goes public, they can raise a lot of money very fast. A recent, and infamous, IPO made Facebook a public company. On the day Facebook went public, it raised $16 billion in funds and made the owners very, very rich. The largest IPO ever raised $17.9 billion when Visa went public in 2008.
Day-to-day decisions of public companies are left up to a CEO and executive team, but the overall direction of the company is determined by an independent board of directors charged with representing the investors’ best interests. Shareholders are given the right to vote on the board of directors and other major decisions at an annual meeting or via a proxy ballot.
How Stocks are Traded on the Stock Market
In the old days in 1792, a stock trade was a fairly straight forward process. The broker representing a shareholder who would like to sell a stock would talk to other brokers and find a broker looking to buy. They would negotiate a price and make a deal. The buyer would pay and the seller would receive stock ownership certificates.
Like most of the financial system, today is a lot different than 1792. However, the principle is the same.
Today, most people buy and sell stock online. Through a browser window, mobile app, or special desktop software, average consumers can buy and sell shares in companies around the world. If you want to buy shares of Coca Cola (NYSE:KO), for example, you just need just need to log into your brokerage account, type in KO, and the process will begin (assuming you have funds in your account to cover the cost).
When you press execute, your broker receives an order to purchase the shares on your behalf. From there, the broker will either sell you shares out of its own holdings at the current market price or go to the open stock market to procure shares on your behalf.
All orders are not simply orders instantly executed and filled when you enter an order. You are also allowed to enter order conditions, which are explained below. Very large orders may take some time to complete and will trade at multiple price points. Those very large trades are generally only made by/for institutional investors.
Types of Orders
A market order is the most basic order type, and probably the most common. With a market order, your trade will execute at the current market price, whatever that may be. If you want 100 shares of Walmart (NYSE:WMT), you will get 100 shares of Walmart at the current market price.
A limit order allows you to define a maximum purchase price or minimum sell price for an order.
Let’s say you want 100 Walmart shares and Walmart is currently trading at $75.00 per share. You think Walmart is a great company to buy, but you think $74.75 is the most you would be willing to pay. With a limit order, you can set the order to execute at any time in the future if Walmart is at $74.75 or lower. If the stock only goes up, you will never get it. If it goes down, for either a brief moment or longer, to your price, it will execute.
A risk is that if you set an order like this and forget about it, you might buy it on the way down to $70, $60, or below. Always stay aware of your open orders and what is pending in your account.
You can use the same logic for a sale. If you own Walmart at $75, and you want to sell it if it reaches $77, you can set an order to sell if the stock hits $77 or above. However, if it hits $77 on the way to $85, you miss out on the upside. If you think it will quickly hit $77 before dropping lower, it is a better deal for you.
With either type of limit order, understand the risks that your order might not execute, or it might execute in a way that doesn’t benefit you as much as a market order may have.
A stop, or stop loss, is an order that does exactly what its name implies. It stops a loss automatically.
If you bought Walmart at $50 and now own it at $75, you might be ready to lock in your profit but still want to ensure you take advantage of potential upside potential. To do so, you could enter a stop order that would sell if it falls below a specific price. If you enter a stop at $70, and the stock drops to $71, you still own it. If it drops to $68, it would have already sold at $70.
The risk of this is that the stock drops to $69.99, your trade executes, and then the stock jumps up to a higher price. If you own it at $75, it drops to $68, then jumps to $80 the next week, your stock dropped $5 per share, you sold it, and then you lost a $10 per share upside gain.
How to Buy and Sell Stock
Know that you know what stock is and how different trades work, let’s walk through buying a stock for yourself.
First, you need a funded brokerage account. I personally use Charles Schwab, but you can also look to companies like Sharebuilder, Scottrade, TradeKing, Fidelity, or E-Trade. For brand new investors, the best place I have found to invest is Loyal3. Through that brokerage, you can buy and sell stock starting at $10 with absolutely zero trade fees.
When choosing a brokerage, I suggest finding a discount broker that offers free research, stock information, and cheap online trades. Also look into customer service reviews, what they allow you to buy and sell (stocks, mutual funds, bonds, IPOs, etc).
Schwab lets you buy and sell for $8.95. Each broker has slightly different fees, so shop around before you choose. I also like that Schwab offers a list of mutual funds and ETFs with no transaction fees. ShareBuilder is popular for new investors because you can buy fractional shares if you setup a monthly recurring purchase.
Once you pick an account, link it with you checking account and add funds. I suggest adding enough to buy stock in $500 increments or more. If you buy $200 of a stock, you need the investment to go up by 10% just to cover your trading fees. If you buy $500, you only need the investment to rise by 4% to cover your fees. If you buy $2,000, the stock only has to increase by 1% to cover the fees.
Once you fund the account, buying and selling is an easy process. It just takes a minute to enter a trade online.
Make sure when you buy stocks that you diversify. If you have $4,000 to invest and decide on $2,000 of 2 stocks, you are at a risk for a big loss. If one of those companies has bad news, 50% of your portfolio is at risk.
If you have $1,000 in four stocks, and that same company has the same bad news, only 25% of your portfolio is impacted.
Diversification means both companies and sectors. If you buy 4 oil and gas companies, and oil and gas prices plummet, your whole portfolio is impacted. Make sure to diversify as much as possible. As the saying goes, don’t keep all your eggs in one basket.
Another option to diversify is through ETFs or mutual funds. I recently purchased the Vanguard Equity-Income Fund (MUTF:VEIPX) in my Roth IRA. That fund has 164 holdings, so buying one fund with low fees gave me easy diversification in large companies that I like for investment returns.
If you buy mutual funds or ETFs, be sure to check into the fees and costs before investing.
When to Buy and Sell Stock
Another important part of investing is knowing when to buy and sell. There are two main camps when it comes to investment timing, investments based on fundamental analysis and technical analysis.
Fundamental analysis is my preferred valuation method. It is also the investment analysis style of the famed ‘Oracle of Omaha’ and Berkshire Hathaway CEO Warren Buffet. Fundamental analysis involves determining the company’s value based on current and projected financial metrics and using that value to infer a stock price.
Based on that “intrinsic value,” investors can decide whether the stock is overpriced or underpriced. That analysis leads to a buy or sell decision.
Technical analysis is more popular for short term traders trying to make a quick buck. I personally ignore technical analysis when making investment decisions, as I am making investments for the long term.
Technical analysis uses indicators such as the moving average and market patterns to decide when to buy and sell. Pure technical analysis is making forward looking decisions based on historic results, expecting that history to be an indicator of what is to come next.
Never, ever buy or sell based on emotion. Always use sound analysis and logic when making investment decisions.
The one time I bought and sold based on emotion, it was a purchase of WWE (NYSE:WWE). I used sound analysis to decide to buy the stock, and it went up and up. While patting myself on the back for making a good buy, I ignored the signs of pending declines because I am a wrestling fan and I was proving myself right by holding on.
Bad choice. The stock went down and down before I gave in and admitted defeat. I lost both my gains and then some more before I sold.
Getting Your Feet Wet Without Financial Risk
If you don’t have the money to get started investing, or you want to give it a try with play money before you put in the real deal, there are great options for stock market games to try your strategy before you implement it.
Another great option is to get started with very little risk. I have an account with Loyal3, a new stock brokerage firm that offers trades on a growing list of companies (currently about 60) with zero buying or selling fees. If you can buy and sell with no fees, there are no hurdles to get over to break even when buying and selling small amounts of stock. Listed stocks include Berkshire Hathaway, Walmart, Starbucks, WWE, Facebook, Google, Apple, Disney, and many other consumer brands.
Your Investment Questions?
Do you invest regularly? What is your strategy? If not, what is holding you back? What questions do you have about investing and the stock market? Please share in the comments and we can work together to make money!
Stock certificate image by Wystan / flickr. Buttonwood image via Wikipedia. Trading floor image by ilamont.com / flickr.