What is the stock market? Seems like a pretty simple question, but in reality it really can be answered about a thousand different ways. Let me try and answer that question for you by laying out the basics of what makes up the stock market. By the end of this article you should have a good idea of what the market it and what you next steps are to get started trading or investing.
What is a Stock?
A stock is a share or a piece of a company. Each share represents a percentage of ownership within a company. For example, say you started a new company and wanted to raise $1000 to start the company. You already have $500 but are looking to raise the remaining $500 and you find two investors willing to put in $250 each for a share in the company. You would then issue stock. You yourself would take two shares and you would issue one share to each of the investors, giving you 50% ownership in the company and each of them 25% ownership. This stock is then what is traded on the stock market once a company goes public.
What is the Stock Market?
The stock market is a place for the sale or purchase of various company’s stocks. There are many stock exchanges throughout the world each representing part of the stock market as a whole.
What is a Stock Exchange?
A stock exchange is an institution that provides services for brokers and traders to buy and sell stock of companies. Some popular stock exchanges are the NASDAQ and NYSE.
How the Stock Market Works?
As mentioned above, the stock market is traded via stock exchanges and these exchanges act as an intermediary between the company and the trader, or a trader and another trader. So, say for instance that you wanted to buy 100 shares of company “xyz,” to do that you would need to use a broker. You would place that order with your broker and the broker would execute the trade for you with the exchange. The broker then charges a commission to complete that trade.
Bulls and Bears?
Calling a market bearish or bullish simply states in what direction the market is moving. If the market or the stock is in an upward trend its considered bullish, if it’s in a downward trend it’s considered bearish.
What is a Broker?
A stock broker is a licensed professional that typically works for a brokerage firm. They buy and sell stock for traders and institutions through a stock exchange, and charge a fee or commission for their services.
What is a Commission?
A commission is a fee paid to a broker to conduct a trade for you. This fee can either be a flat amount per trade, a percentage based on the value of a trade, or a combination of the two.
Trading vs Investing
The biggest difference between trading and investing is the motivation. When investing, someone is looking to hold a stock for a long period of time and to build wealth over that time. Investing typically comes with much less risk than trading and is viewed as a long term strategy. Trading on the other hand, is for people looking to turn a profit quickly. There is typically much more risk involved with trading (whether it be day trading or a longer term swing trade). Trading is a shorter term holding of a position than investing-sometimes for as little as only a few seconds. Technical analysis is often used when trading, as opposed to more fundamental analysis when investing.
Long vs Short
Many traders get tripped up by the terms “long” and “short”. Typically people take these to mean holding the stock for a long period of time or a short period of time. However, going long or going short has a very different meaning in the trading world. When someone says they are going long they are trading a stock in the typical manor of buying and then selling. Shorting is the exact opposite. When someone shorts they are actually selling the stock before they buy it, in hopes that the stock will go down and they will then be able to buy it back for less than they sold it for.
What is a Fill?
There are two types of fills, a partial fill and a complete fill. Basically what that means is if you were to place an order for 100 shares of a stock at $10, and were able to get all 100 shares at that price, it would be considered a complete fill. However, often only some of the shares may be available. In which case, it would be called a partial fill.
What are Market Makers?
A market maker is typically a bank or institution whose responsibility is to add liquidity to the market. The market maker is buying and selling based on the bid and ask prices, and makes a profit based on that spread. Because of the digital transition of the US markets, these market makers are not always specific people or a designated positions-but they do exist. For other markets, like commodities or foreign exchanges, a market maker is still a very crucial position.
What is Market Capitalization?
Market Capitalization, often referred to as Market Cap, is the valuation of a company based on the value of their outstanding stock. Market Cap is calculated by multiplying the amount of stock issued by the value per share. For instance, if a company has 1000 share of stock issued and each share is valued at $10 then the company’s market cap would be $10,000.
What are Level 2 Quotes?
Level 2 Quotes allow a trader to see the entire order book for a given stock. With level 2’s you can see the current bid and ask prices, but also all of the other orders placed above or below those prices. With level 2’s you can see what other people are willing to buy or sell a share for.
What is the Bid and Ask?
“The bid” and “the ask” are simply what any given stock is being sold for or bought at. “The bid” is the price someone is willing to pay for a share. “The ask” is the price at which someone is willing to sell a share.
What is a Stock Split?
A stock split or divide is just as it sounds. It is where the company decides to increase the number of shares, but then adjusts the value of those shares so that the total market cap is the same after the split. For instance, if someone owned 1 share of company XYZ, and it was valued at $10, when the company decides to do a two-for-one split, that person then owns two shares of company XYZ and each share is valued at $5.
Types of Trading
Fundamentals vs Technical Analysis
There are two main types of analysis when it comes to trading and investing-Fundamental and Technical Analysis. Fundamental Analysis is when the trader does their due diligence on the company-their management, their financials, their plans, etc., and then makes a decision to buy or sell based on if they think the company is under or over valued in the market. Technical analysis on the other hand, really does not care what the company is, or what they do, but is purely based on the stock charts, patterns and moves in the chart. Technical Analysis looks at things like supports and resistances, and simple moving averages.
What is Day Trading?
Day trading is very simply defined as buying and selling a position within the same day.
What is Swing Trading? And How?
Swing Trading is a form of trading based on technical analysis. As opposed to day trading, a swing trader is looking at the stock and looking for a longer run. A swing trade can be anything from a couple of days to several weeks. The goal of swing trading is to identify a trend within a stock chart at the beginning-weather it be long or short-and to ride that trend for some period of time. Typically there can be much higher returns per trade with swing trading than day trading, but there are also less trades made over the same period.
How to Trade
There are many exchanges throughout the world for trading all kind of things including stocks, options, bonds, currency, commodities, etc. The exchange is the actual institution that handles the buying and selling transaction. Some of the more common stock exchanges in the United States are the New York Stock Exchange (NYSE) and the NASDAQ. Worldwide there are many more exchanges located in many of the major financial sectors around the world like Tokyo, Amsterdam, Paris, London, and Hong Kong.
Currency vs. Stock vs. Options vs. Commodities etc.
Pretty much anything can be traded or exchanged; however, the most common exchanges are Currency, Stocks, Commodities, and Options. Currency is the trading of different world currencies with the goal of making a profit on the exchange rates, also known as Forex. Stock trading is the buying and selling of a company’s stock. In Options, trading an option is actually trading the “option” to buy or sell a stock rather than the actual stock itself. With Commodities, one would be trading futures of things like orange juice or cotton, based on the projection of what the commodity will be worth at a given date.
Brokerage / Trading Accounts
- Cash Management – a brokerage account opened with cash giving one the ability to buy and sell up to the value of the cash in the account.
- Margin – Gives one the ability to buy and sell with borrowed money from the broker. Margin accounts typically allow one to borrow up to 50% of the purchase price. LEARN MORE
- Discretionary – A discretionary account is basically a cash account that is managed by the clients’ broker who is permitted to buy and sell without contacting the investor first.
How to Open a Brokerage /Trading Account
When opening a brokerage account, the first question you want to ask is what type of trading or investing will you be doing. Some brokerages may be better for stocks, but not ideal if you are looking to trade options or penny stocks. Once you have done your research and found a suitable broker for the type of trading or investing you would like to do, the application process is fairly straight forward. Each broker has their own application process that you will need to go through. Once that is completed, you can transfer funds into the account and begin trading.
Looking for more information about choosing a broker? Check out this complete guide.
How to use a Brokerage / Trading Account
Once you have a funded brokerage account you can begin trading or investing. You will be able to place orders to buy and sell stock or other securities.
There are many types of orders that you can place when trading stocks with your broker. Here I will review some of the more common types:
- Market Orders – Market orders are the simplest to place and most likely to get filled. A market order simply instructs the broker to buy or sell a given stock at the current market price.
- Limit Orders – A limit order instructs the broker to buy or sell a stock at a specific price. This will help control the entry/exit points, but also make it slightly more difficult to get in or out as you are setting a specific purchase or sale price.
- Stop Loss Orders – A stop loss order is used to “stop your loss” in the event the price of a stock falls sharply. A Stop Loss Order is comprised of two order types: Limit and Market. A limit order allows you to set a price below the current price of a stock in the event that the stock hits that price the order will convert into a market order and you position will be sold off at the current market price.
- Trailing Stops – A trailing stop is similar to a stop loss but rather than protecting against loss it protects profits. A trailing stop “trails” the price of the stock position as it increases, and is triggered when the increase stops and reverses. The trailing stop is set as a percentage of the trading value. If the stock falls x percent, then the trailing stop will be triggered and close your position.
- Good till Cancelled – A good till cancelled order instructs the broker to keep the order open until it is cancelled. This is used in conjunction with one of the other order types mentioned above.
- Day Order – A day order is similar to a Good till Cancelled order. However, the broker will automatically cancel the order at the end of the trading day.
- All or None – An All or None order states that the order should only be executed if it can be completely filled. An All or None order will guard against partial fills.