To begin with, stocks represent ownership stakes in a given company. When you buy stock, you are buying a bundle of rights and obligations which come with having equity in that company. A company issues equity to the public when it wants more capital (i.e. money) in order to fund it’s various endeavors. In fact, companies have two main choices when it comes to raise funding: sell debt or sell equity. Selling debt means borrowing money, whereas selling equity means selling ownership stakes. Both have advantages and disadvantages, but one of the chief benefits of selling equity is that you don’t have to pay back the money! Although, of course, your stock holders will expect you to increase shareholder value and perhaps distribute more generous dividends…

What is a stock market? And what is a stock exchange? These terms are often used interchangeably. Well, “stock market” is typically used to describe the worldwide market involved in buying and selling stock, while a given stock exchange is one of the physical locations where stock trades are transacted.

Until not too long ago, stock exchanges were teaming with people whose jobs were to physically trade stocks with one another on behalf of buyers and sellers. These days, most exchanges facilitate this electronically. Stock exchanges also vary in size, ranging from local stock exchanges like the Bendigo Stock Exchange in regional Australia to the massive New York Stock Exchange in New York City!

Unless you have the requisite licence, you can’t directly buy and sell stocks yourself. You need to pay a broker to do so on your behalf. Historically, you might have called an individual broker to transact a trade for you; these days it’s often just a matter of visiting an Internet based brokerage and filling
in an order form.

How to trade stocks comes down to your goals, financial wherewithal, skills and beliefs. In theory, the price of any company’s stock reflects its value. If you’re confident that the value of that company will increase, then so too, should the value of your stock. You can then sell the stock for a profit… or hang on to it. (You might hang on to it if you think the company will continue to do well in the future, or because some generous dividends are on the way, or because your stake is such that you can borrow against it for other investment purposes.)

“Fundamental” investors are those who do in fact take the view that, over time, stock prices reflect the value of a company. How do these investors assess value? Well, they study a range of fundamental information that will supposedly give them a glimpse into the future prospects of the company. This ranges from the company’s own financial health, to the health of the industry in which it operates, to the strength of the economy at large. After performing such fundamental analysis, such an investor decides how to trade stocks they’re interested in.

Short term traders, on the other hand, dismiss the utility of fundamental information. Because their time horizon for trading is much shorter – often varying from a matter of hours to a few days, sometimes longer – they see a market that is much more volatile. Within hours, days, weeks or even months, the stock price of a company may not only vary widely, but also bear little resemblance to the company’s financial performance.

Traders therefore often opt for a “technical” approach to the stock market. They use technical analysis, which involves analyzing and modeling price data, to inform their trading activity.

Depending on your objectives, financial resources, abilities and views about things, either a fundamental or technical approach may appeal to you more. However, there are also professionals who, after learning the various theories about how to trade stocks, also use both. Whatever approach someone uses, it’s generally embodied in some kind of trading system.

A trading system is the systematic process used by a trader to govern how they trade. There are probably as many trading systems as there are traders, and plenty of books, home-study courses, seminars, etc that also claim to teach profitable trading strategies and systems. Indeed, many traders say that the most important determinant of being successful in trading is having – and sticking with – a tried-and-true system.

I hope this overview has given you an idea of how to trade stocks. There is certainly more to grasp, but at least you now have a foundation in how the stock market works.

By: Mark Crisp

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