It’s never been easier to access the stock market than it is today. While the idea of investing in a potentially lucrative stock appeals to everyone, the learning curve for investments is thought to be steep — too much for many people to consider dipping their toes into the stock market.
We think it’s much easier to grasp the fundamentals of the stock market than many new investors believe. Below is a brief description of the basic structure, development, and tools of the securities market designed to help all newcomers learn about stocks and investing on their own.
Why We Invest in the Stock Market
The first step in learning about stocks and investing is to understand why people do it. Overall, the answer is very simple…to grow the amount of money they have.
Adult consumers are often familiar with the concept of having a savings account. You go to work, you get paid, you set aside a sum of money for living expenses, and you put the rest in savings for things you’ll need in the future — large purchases, retirement, college funds, and so forth.
Savings accounts are safe and necessary features to an overall financial strategy. They also offer modest earnings in the form of interest — the longer you keep money in savings, the more it grows. This is because banks use your funds to issue loans to other customers, who must pay interest when they repay those loans. A financial institution pays you an interest rate on your savings account for your trouble (which usually isn’t that much trouble).
Stock investments work the same way. You invest in a company; they use your capital to fund projects, maintain operations, and develop business. In return for your investment, companies issue you a “reward” in the form of higher stock value, and with some companies, a quarterly payout known as a dividend.
The difference between stocks and savings accounts is the risk involved. Savings accounts at banks are generally risk-free. They’re federally insured, easy to manage, and at least a little profitable. But they don’t generate a ton of revenue.
Stocks, on the other hand, entail some degree of risk. When you invest in a business, you’re putting a stake in its future success, either for the short-term or long-term. If the business flat lines, you’ll probably lose a certain amount of share value. But if the business succeeds and thrives, your share value will increase at a much faster rate than a savings account would.
That’s why people invest in the stock market. Even though it involves a certain level of risk, it has a history of continuous growth over hundreds of years, dependably rebounding from economic crises and offering profits to those who navigate it well. Along with savings accounts, real estate equity, and other financial instruments, the stock market is a proven method to accelerate personal wealth for those who take time to learn about stocks and investing.
What is Stock?
From a distance, the stock market looks like a complicated machine, featuring a ton of options, offerings, and intricate mathematics. That’s enough to deter some shy folks away from investing. But understanding the stock market is actually fairly simple.
When you buy a share of stock from a company, you’re actually purchasing partial ownership of that company. This concept of ownership is called equity. You become a shareholder. The company uses all the money it gets from stock payments to fund all of the varied arms of its business — everything from purchasing raw materials, paying staff, and keeping an office to researching new products, marketing, and manufacturing.
As an equity holder, you make a tangible contribution to that business. When the business grows and becomes successful, your equity value increases and the price for your stock goes up. Conversely, when the business fails or experiences a downturn, your stock value will likely decrease.
What is the Stock Market?
Stocks are sold on the stock market. It’s a broad term referring to all of the various marketplaces and platforms where securities and commodities are traded between investors. In the physical world, these transactions happen in stock exchanges — such as the New York Stock Exchange (NYSE) — where companies post the stock shares they want to sell.
If physical stock exchanges didn’t exist, companies would have to find potential buyers themselves. Instead, the NYSE and other stock exchanges around the world offer these shares to the public so that the company doesn’t have to manage the transactions themselves. That’s why the stock market is considered a secondary market.
Most of us probably picture the stock exchange floor as being a bit of a madhouse, and there’s a good reason for that. Before the advent of electronic trading, stock traders took to the floors of the NYSE every weekday and made bargains to buy and sell shares, much like an auction. This style of trading is called “open outcry.”
Although you still find stock traders on the NYSE floor, electronic trading has changed a lot of that day-to-day activity. NASDAQ is a stock exchange without a true physical presence — everything is done electronically. As online stock brokerages grew and more people had the chance to learn about stocks and investing, they had greater access to buying stock. E-trading soon became the norm.
What Types of Stocks Can You Buy?
Stock shares are divided into two categories:
- Common Stock: This is the basic stock unit (hence its name). It signifies partial ownership in a company, meaning you get a share of company profits and the right to vote on certain company matters. These gains are reflected in higher share values, and in some companies, the issuance of quarterly dividends to stockholders. Common stock is subject to a lot of volatility — while most professional stockbrokers successfully manage their portfolios to be profitable, they’ll undoubtedly have a few shares of common stock that have lost value.
- Preferred Stock: Shares of preferred stock are usually issued with a guaranteed, fixed dividend — something you can’t get with common stock. If a company needs to liquidate its assets through bankruptcy, its preferred shareholders are the first to receive a payout. This makes the preferred stock less volatile, but that also restricts how much value it gains. Also, preferred stock owners don’t get voting rights.
Common stock is most suitable for those getting into stock trading for the first time, as it’s the easiest to understand and conduct transactions with. Preferred stock may make sense as you get more experienced in the stock market, but common stock is the way to get started.
How is Stock Classified?
Within the stock market, businesses are divided up according to several factors.
Market Capitalization
This is mainly just an indicator of how much value a certain company has, or more simply put, how big it is. Companies are typically divided into three capitalization buckets:
- Large Cap: Market value of $10 billion or more
- Mid- or Medium Cap: Between $2 and $10 billion
- Small Cap: Between $200 million and $2 billion
There’s also a tier called micro cap, with companies valued between $50 and $300 million. Micro-cap companies are generally very volatile or inexperienced and are usually more appropriate for experienced investors, rather than those just beginning to learn about stocks and investing.
Growth vs. Value Stock
This description can be a little tricky because a company can be a growth stock at certain stages in its existence and a value stock at other times.
- A growth stock is usually connected to a company that’s growing extremely quickly or is about to do so. Investors are willing to pay more for shares in growth stocks because they expect returns to be bigger more quickly.
- Value stocks are low-priced, and as such, they may be considered undervalued. A value stock may be issued from a company that’s going through a rough time or is being overlooked by the industry in general. Investors snap up value stocks when they’re inexpensive if they believe the company will eventually regain its value and reward stockholders more handsomely.
Blue-Chip vs. Penny Stocks
These aren’t “official” designations, but are terms are used frequently to describe companies on opposite ends of the financial spectrum:
- A blue-chip stock belongs to an industry titan — huge, internationally known companies with strong reputations for success, growth, and speedy recovery from business declines. They include Apple, Coca-Cola, 3M, McDonald’s, Boeing, and so forth. Blue-chip stocks are considered safe investments because of their long track records of success.
- A penny stock usually represents the exact opposite of a blue-chip stock. It’s for a company that has extremely low market value or is just starting up, typically offering stock for less than $5 a share. It should come as no surprise that these kinds of companies are extremely volatile and loaded with risk, even though they’re cheap. For those just beginning to learn about stocks and investing, penny stocks are not suitable or dependable as a platform.
Business Sectors
Perhaps the most informative kind of stock classification for a certain business is what sector it represents — namely, what the company actually does. All companies offer a certain branch of products or services, and their business sector classification indicates what kind of things they concentrate on.
As of now, there are 11 different business sectors:
- Communication Services: Formerly known as “telecom,” this sector includes companies whose products provide or facilitate communication or entertainment, including movie studios, cable companies, phone companies, social media companies, and so forth.
- Consumer Discretionary: These businesses are the ones that produce goods marketed directly to consumers — i.e., you and me — that typically aren’t bought very often. These include cars, restaurants, hotels, cruise lines, jewelry, vacations, and so forth.
- Consumer Staples: Businesses that produce or sell items that consumers buy regularly are known as consumer staples. This branch includes manufacturers like Colgate, Pepsi, and Procter & Gamble, as well as retailers like Wal-Mart and Kroger.
- Energy: These are companies that focus on producing and refining energy sources, such as fossil fuels (gas and coal) or sustainable energy (like wind and solar power).
- Financials: These firms offer financial services to both public and private customers: Banks, stockbrokers, online payment services, credit companies, investment houses, and so on.
- Health Care: This sector covers manufacturers of medical equipment, medical providers, and pharmaceutical companies.
- Industrials: Companies that produce large-scale goods like airplanes, industrial machines, transportation services, and infrastructure are known by this moniker.
- Information Technology: Companies that focus on computer software, hardware, and semiconductors for the digital age work in this sector. This category includes Apple and Microsoft, as well as individual component makers like Intel.
- Materials: Companies that convert raw materials into useable products, such as mining operations, logging works, chemical companies, and so forth, would be classified as belonging to the materials sector.
- Real Estate: This is a sector that covers most entities in the real estate business, including realtor companies, property management, real estate websites, storage facilities, and others.
- Utilities: Businesses that provide fundamental services like gas, water, and electricity to certain regions belong to the utilities sector.
Every company on the stock exchange fits into one of these 11 broad categories. Within each sector, further divisions indicate what specific industry a company works in. For example, the Materials sector is broken down into five more specific categories: Chemicals, construction materials, containers and packaging, metals and mining, and paper and forest.
Diversification
When you’re building a stock portfolio, it’s always a good idea to invest in multiple companies across a broad range of business sectors. Tying up all of your investments into a single corporation makes your portfolio disproportionately reliant on just that one company. If that company goes out of business, your whole investment budget is worthless.
Similarly, someone who invests entirely in just one sector — say, all real estate companies — can face significant losses if the entire business sector suffers a downturn. A diverse portfolio helps mitigate risk by spreading it around.
There are a few mechanisms that help investors to make their portfolio “instantly” diverse without too much effort:
Mutual Funds
A mutual fund is a company that “pools” money together from parties and invests them in different securities. Mutual funds manage their portfolios to be diverse in both business sector and traditional investment methods, so they include everything from money market funds and bonds to corporate stocks.
Exchange-Traded Funds
An ETF is also a fund that covers a broad range of companies. Unlike mutual funds, though, you trade ETF shares on the stock market, just as you would with common stock. An ETF usually focuses on a certain kind of stock, and the classification possibilities are endless. You can buy ETFs devoted to tech, healthcare, emerging markets, all small-cap companies, and all software manufacturers — whatever classifications appeal to you.
Learn About Stocks and Investing with Gorilla Trades
Gorilla Trades is a valuable resource for anyone looking to take initial steps into the stock market. We offer a proven stock-picking strategy based on real-time, dependable information that takes most of the hard research off your shoulders. Contact us to set up a free trial.