Stock market basics
When a company needs to raise working capital, it will sell stock or units of ownership in the company to outside investors. Once you buy the stock, you are now a shareholder in the company.
At the end of year if there is a profit, the company may pay dividends to its investors. If there is no profit, or even a loss, you as a shareholder are not responsible to make up the shortfall of cash.
If there is a loss, most likely the amount you invested is now worth less than when you started. Your options at this point would be to hold the stock, hoping the company makes a profit in the future and you recoup your current loss, or you sell it now at a loss and move on.
If the company is large enough, its stock is traded on an exchange. This is where stockbrokers and traders buy and/or sell stocks (also known as equities), bonds and other securities on your behalf. Most U.S. trading takes place on the New York Stock Exchange, but there are many other exchanges in the U.S. and around the world.
Normally when we think of the “stock market,” we think of the Dow Jones Industrial Average, the Standard & Poor’s 500 or the Nasdaq Composite. They are not trading markets; they are indexes that measure different sectors of the stock market. If the stock prices of the companies listed within the index go up or down, so does the index.
The different sectors or industries that are tracked within the various indices include large and small companies, industrial, technology, health care, utilities, consumer goods and financial. The ups and downs of each sector provide information as to the overall health of the economy.
The Dow Jones Industrial Average is often referred to as the DOW; however the accurate acronym is DJIA. The company that produces the Wall Street Journal is Dow Jones & Company (DOW). It also operates the DJIA. The DJIA index consists of 30 large U.S. companies.
The S&P 500 index includes 500 of the most widely traded stocks, usually larger companies, and all the various sectors are covered within this index.
The Nasdaq Composite index consists of 5,000 companies largely in the technology and growth sector. There are also a number of small and speculative companies listed, which can make it more volatile than the Dow or S&P 500.
What can you buy on the stock exchange? You can buy stocks, bonds, ETFs, mutual funds, commodities, bonds and Treasury bills.
A mutual fund is a professionally managed investment fund that pools money of investors to purchase stocks or bonds from various companies. You don’t really own the stocks or bonds from the various companies; your ownership is in the mutual fund itself. If the professional manager does a good job buying and selling within the fund, then you make money.
ETF stands for Exchange Traded Fund. These are similar to mutual funds; they hold assets like stocks, bonds and even commodities. They have stock-like features and are low cost. Commodities are things you can actually touch like metals and grains.
Bonds and Treasury bills are similar fixed-income investments and the safest investment type we have discussed. If held to maturity, your principal investment will be repaid. With a bond, you receive interest on a regular basis, and with the Treasury bill you receive your interest upon maturity. Understanding the stock market is an important first step to understanding how to manage your investments.
Posted: Thursday, April 21, 2016 9:31 am
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