A stock market is a place where stocks are being bought and sold. A stock represents ownership of a company or a corporation. It is intangible and proof of having ownership is by means of a document called stock certificate. People who holds a share of stock is a part owner of a corporation, they are called investors or stockholders or shareholders. A corporation may also buy shares of stocks; therefore, it can also be an owner of and manage another corporation thru the people governing it. This is possible because in the point of view of the law, a corporation is a legal entity or person, born out of law itself. It may not eat, drink or sleep like a natural person but it is still a person, legally, therefore having its own rights, and one of those rights is to buy shares of stocks of other corporations.
Stocks may be publicly listed or unlisted. A publicly listed stock means that it can be bought by anyone in the public thru the stock market, while unlisted stocks are stocks, well of course, not offered to the public.
People and corporations invest in stocks to earn profit. And they can earn in two ways, one is through price appreciation and the other is through dividends. Stock price changes rapidly and may go up or down in just a matter of seconds depending on the number of trades that happens. Most people take advantage of these fluctuations; they are short-term investors or more commonly known as traders. While others go for the long-term and wait for prices to go way higher; they are long-term investors or simply called investors. Prices go up and down because of supply and demand. Market price is the last or most recent price that a buyer and a seller have traded or agreed upon, on a specific stock. It is where the forces of supply and demand meet.
Supply and Demand – Price Fluctuations
To illustrate this supply and demand thingy, I want you to imagine that you have $1,000 cash and want to invest it on something that will give you a nice return for your money. Your friend, after knowing this, came to you and invited you to invest in his newly formed shoe business, he operates by means of consignment with big shoe companies like Nike, Adidas, Fila, Caterpillar and Puma, just to name a few. Having a small capital, he’s having a hard time expanding and needs additional cash from investors to fund his expansion. He wanted to not only enter the shoe business but also include different clothing apparel; from infant wear, ladies’ clothing to adult diapers. Seeing his enthusiasm in the business, you agreed to his proposal, wrote an agreement and gave the money to him.
A year had passed and true enough his plans was starting to come true, your business is booming, profits are getting higher and higher, customers are coming in from all over the place. He now plans to turn the small shoe store into a department store. His plans go on, he want to reinvest the profits, get a loan from the bank and turn it into a mall and enter the leasing business as well. He added that he plans on putting a food court where different fast foods are bunched up together. There will also be electronics stores, hardware stores, video arcades for the kids while parents go shopping. And it doesn’t stop there; new malls will rise up one at a time until malls will be everywhere. Then, some friends of yours got to know about this, they got interested and now wants to be part of your growing business. They then ask you if you would like to sell your half of the ownership to them. They are so determined to be part of the growing business that they’d fight over it. One proposed that he’ll walk your dog, feed it, make it poop outside and groom it every morning in a week, even though your dog died three months ago. The other, would clean your car while wearing only a two piece bikini..oh, did I mention that he’s a guy?! While the other says he would clean your house, every wall, bathroom, bedroom, everything, inside out, but only after the maid has tidy up the place. They’d ask you every day, during breakfast, lunch and dinner and in your dreams through mental telepathy. And so you give up, and asked them, “Ok guys, how much are you willing to pay for half of my share in the business?” One answered, “$600 cold cash!”, “I’ll give you $800,” says the other. “HAHA!” laugh out loud by the last one. “I’ll give you a thousand bucks for half of your ownership you are currently holding!” he said boldly. Surprised by the amounts each one is offering you and them seeing dollar signs all over your face, you became more eager to sell your share; and immediately sold it to the highest bidder. The market price in this case is the $1,000 because it is where you, the seller, and your friend, the buyer, agreed or meet. You may now stop imagining.
And so, that is how supply and demand works in the stock market. On one hand, when more investors are willing to buy (demand increases), the more that prices goes up. On the other hand, when more investors are willing to sell (demand decreases), the more that prices goes down. Every investor has his own perception of the stock’s value that they are buying or selling. Your friends are willing to pay more than the original cost of your investment because they believed that in the future, the value of their share in the business will be much more than what they currently paid for. How much an investor currently sees the value of the stocks is called perceived value.
Now how do dividends work? Let me continue the story so that you may also continue your imagination starting with this. Another year had passed and profit was still peaking up. Sales are booming, new ideas keeps coming in, products are sold immediately and the cash register is overloaded. Since profit were huge, you and your friends (the investors/owners as managers) decided to take a portion of the profit for yourselves; that portion of the profit that you took out is called dividends? Dividends are part of the profit that is shed out to investors or the owners of the business. Going back, the portion that you did not take is reinvested in the business. In accounting, this is termed as retained earnings, earnings that are retained for a certain purpose, usually, for the growth and expansion of the business. Stable and secure companies are the ones who mostly distribute dividends. There are many kinds of dividends but the most common are cash dividends, stock dividends and property dividends.
- Cash dividends are payouts in the form of cash, just like in the example above.
- Stock dividends are payouts in the form of the corporation’s own stocks, hence, increasing the number of shares you are holding.
- Property dividends are payouts in the of assets of the corporation other than cash, it may be products, parcel of land, tools, investment in stocks in other corporations, etc.
Emotion Driven Market
The stock market is emotion driven. In the story above, you sold half of your ownership share because of the emotion of excitement after hearing those prices being offered to you. Now what if in another version of this story, business is failing, sales are at its lowest, products have cobwebs and the cash register has a fly going out whenever the cashier opens it. While going out of the store, you overheard your friends talking; “I’d buy half of his share for $400” says one of them. The other one says, “With those things happening in their business, I’d only pay $300”. “HA! They’d be lucky if I’d pay them $100” blurted out by another. So in this case, after hearing those prices, and considering how business is going down, emotion drives you to think that rather than losing all your money, you’d rather sell it to the one with the highest offer even though you won’t be able to recover all of your investment, you’d think that at least not all of it was lost. In reality, this kind of thinking also happens in the stock market. Greed and fear are the two most common emotions surfacing on people getting in the market.
Technicals and Fundamentals
Even you must have felt the emotion of excitement of earning double the cost of your investment or panic of seeing your investment losing its value. This is where technical and fundamental analysis comes into play; these tools help people getting into the stock market become more objective in their decisions. Technical analysis is the study of price movements or fluctuations using historical chart patterns and trends, so that analysts may be able to determine the future behavior of the stock; while fundamental analysis is the study of the intrinsic value or real value or underlying value of a stock using real data and everything that can affect a stock’s value, so that analysts may be able to compare it with the stock’s current price and determine whether the stock is underpriced or overpriced because of investor’s perceived value.
Traders use technical analysis as a tool for forecasting where stock prices will go and, yes you guessed it right, investors use fundamental analysis to determine whether investing in a certain stock is viable on the long-term standpoint. Technical and fundamental analyses are opposites of each other. One can’t use the other for long-term, the same as the other being used for short-term. Neither is more important than the other, it totally depends on your market strategy whether you’d go for the short-term as a trader or the long-term as an investor.
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