How to Understand the Stock Market

Before you join the fray, here are some key steps to take toward building an understanding of the stock market.

Difficulty: Moderate

Instructions

Things You'll Need:

• Financial Calculator
• Internet Access
• Brokerage Accounts
• Paper And Pencils
• Computers

1. Understand 'equity securities.' As an equity investor, when you buy stock you take an ownership stake in a company and assume a corresponding degree of risk.

2. Learn the language of the market, familiarizing yourself with such financial terms as 'price-earnings (PE) ratio,' 'margin,' 'option,' 'earnings per share' and 'leverage.'

3. Analyze the holdings of several successful mutual-fund companies, noting which stocks they have held - and dumped - over the past three or four years.

4. Read the quarterly and annual reports that several large corporations have filed with the Securities and Exchange Commission (SEC).

5. Research companies that you have personal knowledge of and a high degree of confidence in. Evaluate their SEC filings, looking for trends that indicate growth and continuing profitability.

6. Get online. Dozens of companies offer financial news, advice and analysis online (see 'eHow to Research Stocks to Buy').

7. Take advantage of all the information your brokerage has to offer regarding individual stocks. Know what you are buying - and why - before you invest.

8. Invest on paper for a few weeks and carefully monitor the performance of your would-be portfolio before you actually start plunking down your money.

Tips & Warnings

• Invest in reputable companies and stick with them for the long haul.
• Some full-service brokerages charge as much as $150 per stock trade, while some discount brokerages charge as little as $8 per trade.
• Set up an electronic portfolio of your stocks through an online service such as Yahoo Finance. This will allow you to monitor your stocks' performance throughout the day and to get the latest news about the companies you've invested in (see "eHow to Monitor Stocks').
• If you don't have the time to do your own research, invest in a no-load mutual fund that has had good returns for at least the past three years.
• Be prepared for a roller-coaster ride. The market can be volatile.

[handyblog]

on 9/15/2009 AnalyzeStock.com

[laxmi]

on 9/29/2008 i am confuse regading +,-figures

[LTSLAW]

on 9/19/2007 Very Informative stuff!!!!!!!!

on 3/21/2006 Seeing how stocks raise and fall, don't just throw your money on one right off the bat. Wait 5 days and monitor the 2 or 3 stocks you think are good. Then buy the best one.

on 2/21/2006 Much of the advice on here and related eHow entries has to do with understanding stock basics, but not how the actual market works. Since this entry is about how to understand the stock market, I figure the points I make will be pertinent to complete novices in stock, futures, and options markets.

Many of the people reading these manuals might get the sense that there is some rationality to the stock market. Not necessarily.

The stock market (and futures and options markets) are public forums for trading shares or contracts of liquid assets. The basic rules governing the market dynamics are the economic forces of supply and demand. The reasoning is straightforward enough and doesn't require an explanation here (if an explanation is needed, either use eHow or Wikipedia to research the basics of economics).

The goal of many would-be investors in the stock market is to make money on price changes during some time period. Indeed, since there is nothing you can physically do to improve the value of your shares, the only thing you can do is to ride temporal price fluctuations. However, consider what you are actually investing in, given the economic basics outlined above. Is the value of your investment based on the underlying company's performance? No. Is the value of your investment based on some squiggly lines you draw on a graph or some numbers you crunch in a spreadsheet? No.

So what is the value of your investment based on? The publics choices regarding the demand/supply in the underlying company's stock, which could be based on virtually any reasoning, both logical and illogical. Since the public, by definition, includes the widest possible range of rationalities in potential investors, you don't know for certain why your investment is being valued differently between any two given time periods.

Contrast this with betting on the outcome of a football game: There are two teams (there are two forces: supply and demand) and one will dominate the other and win. There's no difference. Both forms of investment (gambling) are based on the publics perception of which side, or force, will win out, in either the short run or the long run.

If you are an extreme novice to the stock market, the best advice is to NOT invest. Your odds of succeeding are at best 50-50, but since there are transaction costs associated with trading, your net outcome over a long period of time will be a negative value equal to the total of all the transaction costs.

Leave the technical analysis, fundamental analysis, infomercials, get-rich-quick books, seminars, newsletters, and software for the fools that allow themselves to get parted from their money too easily. Besides, the people hocking that information are usually salesmen, not experts, and are typically not interested in seeing you make a dime using their methods.

While you should get a rough understanding of the rationale behind technical and fundamental analysis (and every kind of "analysis" for that matter), ultimately, your investment decisions should not be governed by the results of any non-economic analysis. You can get information on both of the above kinds of analysis for free on the Internet.

Instead of wasting money on poor investment choices, do the following: Observe the markets, research the different means by which the public comes up with its choices (as cheaply as possible), if possible determine which means the public applies to whatever market you are observing, apply sound economic principles, "paper-trade" if necessary, and see if you can get the knack of predicting where the public likes to throw its money.

When you are capable of putting together a string of successful predictions, consider investing, if only as a means of exploiting your freak talent. After all, the publics choices are what you are investing in.