Stocks, markets and investing are often bewildering terms for most laymen. While there are stories galore about how some people made it big at the stock markets with millions in earnings, the average guy keeps wondering how it all happened. It is no luck, but careful market study and intelligent investment strategy that brought it all.
We take an in-depth look at stock markets, history and terminologies, investments, and a safe approach to making money at the bourse.
Let’s begin with the personal account of an investor and explain the rest of the process.
Data reporter Aditya S., 33, began investing in stock markets a little over five years ago back home in Bangalore, India.
And like many other newbie investors in their twenties, back when Aditya started, he was also not too keen to use a big chunk of his savings to buy or sell shares – at least not at first.
This was simply because he initially felt that it was too risky to buy stocks directly on the stock market. Instead, he began investing a small portion of his income little by little.
But as his confidence grew, Aditya began to gradually learn the ropes to trade shares in real-time on the live market. So even though he made a few losses initially, his profits began to grow over time as well.
“Even despite my comparatively lower tolerance level for any big risk, I bought and sold shares worth Rs70,000 (about Dh3,500) in the past few years, and managed to make a profit of about Rs20,000 (about Dh1,000) – which is about a 30 per cent return on my initial investment,” explained Aditya.
There are two possible ways to make money on stocks, Aditya learnt. “The first way is when a stock you own appreciates in value - that is, when people who want to buy the stock decide that a share is worth more than you paid for it.”
“They might decide that because the company that issued the stock has earnings that are improving, for example. If you hang onto a stock that has gone up in value, you have what's known as unrealised gains. Only when you sell the stock you can lock in your gains.”
Since stock prices fluctuate constantly when the market is open, you never really know how much you're going to make until you sell, Aditya added. “The second way is when the company that owns the stock issues dividends - a payout that companies sometimes make to shareholders.”
How do stock markets work?
A stock market simply lets buyers and sellers negotiate prices of a stock and make trades – which is why the term is often interchangeably used with a ‘stock exchange’.
If one trades in the stock market, it means that they buy or sell shares on one (or more) of the stock exchange(s) that are part of the overall stock market.
But how does a ‘stock’ come about?
Essentially, companies publicly list shares (or stakes) in their business on an exchange through a process called an initial public offering or IPO.
You as an investor buys those shares, which allows the company to raise money to grow its business. And investors trade shares so that their money won’t stay idle but instead keep working gains for them.
The main reason investors own stock is to earn a return on their investment, because the value of a stock grows as the business grows. There is also one other way investors make money on the market.
The stock also pays dividends to investors. Not all stocks pay dividends, but many do. Dividends are payments made to shareholders out of the company's revenue, and they're typically paid quarterly.
What exactly does the stock market measure?
Stock prices change every day by market forces. But what are these ‘market forces’? By this, we mean that share prices change because of supply and demand. Let’s break it down further.
If more people buy a stock (demand) instead of selling it (supply), then the price moves up. Conversely, if more people sell a stock instead of buying, there is more supply than demand and the price then falls.
Supply and demand are easy to grasp. But what makes people like a particular stock and dislike another stock? This comes down to figuring out what news is positive for a company and what news is negative.
There are many answers to this and different investors have varying strategies. That being said, the principal theory is that the price movement of a stock indicates what investors estimate a firm is worth.
So in other words, it’s that supply and demand help determine the price for each security or the levels at which stock market participants — investors and traders — are willing to buy or sell.
Historically, stock trades likely took place in a physical marketplace. These days, the stock market works electronically, through the internet and online stockbrokers.
Each trade happens on a stock-by-stock basis, but overall stock prices often move in tandem because of news, political events, economic reports and other factors.
Who is a shareholder?
Are shareholders part-owners of the company, or are they silent investors with no real role, or people who can influence company decisions in some way? Moreover, how does a company’s profit or loss reflect on a shareholder’s investments?
A shareholder also referred to as a stockholder, is a person, company, or institution that owns at least one share of a company's stock, known as equity. Because shareholders essentially own the company, they reap the benefits of a business's success.
If you invest in the stock market, you're already considered a shareholder, or what is also referred to as a stockholder. Shareholders, as part owners of a company, also have the right to vote in some cases regarding matters of the company and can get dividend pay-outs when the firm is doing well financially.
Will owning a share make you a part-owner of a business?
When you buy shares, you're buying a share of the company's assets and its profits. In fact, you're a part-owner of the company.
But many new investors have misconceptions about the benefits and responsibilities of being a shareholder. Many of these misconceptions stem from a lack of understanding of the amount of ownership that each stock represents.
For large companies, such as US-based Apple, one share is merely a drop in the pond. Even if you owned $1 million (Dh3.67 million) worth of shares, it would still be a small drop in a very large ocean of equity in the global tech giant - $96.5 billion (Dh354 billion) to be precise.
So what does this mean?
Stockholders own shares of a company, but the level of ownership may not present the benefits and responsibilities sought after.
Most shareholders have no direct control over a company's operations, although some have voting rights affording some authority, such as voting for the board of directors members.
Being a shareholder does not mean that you are entitled to discounts or can seize assets and property at will. Although the terms ‘shareholder’ and ‘stakeholder’ are often used interchangeably, many people think that they are one and the same. However, the two terms don’t mean the same thing.
A shareholder is an owner of a company as determined by the number of shares they own. A stakeholder does not own part of the company but does have some interest in the performance of a company just like the shareholders. However, their interest or stake may or may not involve money.
How do I decide which stock market or which stocks to buy?
With tens of thousands of stocks to choose from, how do you go about selecting a few worth buying? Whatever some experts suggest, it's just not possible to comb through every company’s balance sheet to identify those that are in a favourable position to earn more or those that are on a downward trend.
When trying a hand at stock picking, your goal is to find a good value – especially if you plan to hold on to a stock for a while. Veteran investors opine how you don’t need to invest in a market based on which stock market makes the most gains or which stock market has the biggest companies.
The first step to picking investments is determining the purpose of your portfolio. Everyone's purpose for investing is to make money, but investors may be focused on generating an income supplement during retirement, preserving their wealth, or on capital appreciation.
Each of these goals requires a very different strategy. Investors who aim at wealth preservation have a low tolerance for risk, by nature or because of their circumstances. They prefer to invest in stable blue-chip firms. These are stable, profitable, and long-lasting businesses that are relatively safe investments.
Investors who are looking for capital appreciation are looking for the stocks of companies that are in their best early growth years. They are willing to take a higher degree of risk for the chance of big gains.
A more aggressive investor should always earmark a percentage of their portfolio for blue-chip stocks to offset any losses. This is why they say that it helps to diversify one’s investments.
The more diverse your investments are, the lesser the risk on your savings. Also stay clear of the dangers associated with over-diversifying your investments, which only reduces profits.
It's vital to keep up with market news and opinions. Reading financial news and keeping up with industry blogs by writers whose views interest you is a form of passive research. A news article or blog post can form the foundation of your investment style.
What is a stock market crash?
Movement in stock prices is determined by a number of factors ranging from the performance of companies, sectors, macro-economic variables such as GDP growth, fiscal strength of the government, debt burden, inflation, cost and availability of credit. Sometimes the price movements may also be driven by events such as natural disasters, the death of a leader, the outcome of an election and or any major geopolitical events such as border disputes, terror attacks and wars.
While range-bound movements (plus or minus 3 per cent) in the stock prices on a daily basis are normal, a significant drop in share prices over a relatively short period is termed as a crash and smaller drops are referred to as corrections.
There are many definitions of what a stock market crash is. Some categorise a crash strictly as a stock market or a stock market index (a representative sampling of stocks) losing more than 10 per cent of its value in a single day. Others provide a more general view, simply stating that a crash is a significant or dramatic loss in the stock market's value, and the prices of shares overall, usually within a short period of time.
Any way you look at it, a stock market crash happens when confidence and/or value placed in publicly traded assets goes down, causing investors to sell their positions, and move away from active investing, and towards keeping their money in cash, or the equivalent.
What are the signs of stock prices overheating?
Overheating of stock markets comes with clear signs such as excessive rise in stock valuations largely driven by cheap and abundant leverage (credit). Credit drives prices beyond the fundamentals and irrational exuberance become the norm as markets begin to believe that prices can move only up.
Speculative buying driven by cheap credit is the beginning of a correction and or an impending market crash. Factors such as an abundance of liquidity, rising inflation, an overheated economy with high growth rates, low unemployment rates and a rise in wages are indicators of major price corrections on the market.
How does inflation impact stocks?
Rising inflation is typically one of the first signs that an economy is overheating. As a result, governments and central banks will usually raise interest rates in an attempt to lower the amount of spending and borrowing. While central banks can combat rising inflation through interest rate increases, they often come too late. Because inflation is a lagging indicator, it can take a while for changes in policy to reduce the inflation rate. However, the impact of a rise in the interest rate on stock prices is immediate. Even indications of central banks tightening policy rates unnerve the markets.
Excessive inflation in itself is detrimental to investor confidence. As inflation debases currencies, nominal values of investments get inflated and shrink in real terms.
The recent corrections of the world’s leading markets are driven by the fear of potential interest rate hikes warranted by rising inflation. In addition, uncertainties relating to the Russia-Ukraine geopolitical risks and increasingly hawkish monetary trajectories in developed markets will continue to fan market volatility ahead.
What should people do if the stock market crashes?
Panic is the worst enemy of stock market investors. Panic breeds further panic and a crash is certain. Yes, it's hard to hold on and watch your portfolio balance shrink. But unloading when prices are falling is rarely a winning move. Markets tend to shift back over time and you could end up losing money in the long term if you sell when shares are low. History shows that crashes can be short-lived, and prices are likely to quickly rebound.
One advance strategy [to face a correction] is to ensure that you have a strong mix of defensive stocks in your portfolio. These are securities that are much less influenced by disruptions in the market and tend to be in industries considered to be essential, such as utilities and food. If the market crashes, they may feel some financial pain. However, it will be much less than with cyclical stocks, which are in industries greatly dependent on a flourishing economy to grow.
If you see economic conditions start to shift toward leaner times, and stocks seem to be entering a prolonged sluggish phase — a bear market — you may want to pull part of your investments out of the market and place them in a safer financial product that can still earn money. Shifting to CDs [certificate of deposits] or bonds when price gyrations are severe is an ideal defensive move. This can safeguard the investor until things stabilize.
Why are some shares traded on a stock market while others aren’t?
Companies sell stock to raise funds to operate their businesses. These funds can be used to pay a debt or make new acquisitions to expand the business. A company listed on any exchange must meet stringent requirements set by the country’s stock market regulator. Therefore, a company that meets these norms and lists on the market gains credibility.
There are other ways of raising funds as well, such as taking a loan or issuing bonds.
With $100, how can I invest in stocks?
Investing in stocks can be done by opening a trading or a Demat account with the brokerage. Several banks and financial services companies also allow individuals to open trading accounts. These days, there are many intermediary companies that allow the opening of trading accounts digitally. These companies, licenced and approved by the country’s regulators, validate a potential investor’s profile before allowing investments in stocks.
A few things to keep in mind before you start investing
Any person wishing to invest in stocks should be clear about a few aspects: the lump sum target, risk appetite, and period of investment. Stock markets can be volatile, and all investments are bound to see choppy waters in the short term. Therefore, investments should be medium to long-term for best results. Short-term investments can also work, provided thorough research has been done into the company’s financial health and performance. In the case of passive investors, who are not able to constantly track the performance of a company and instead depend on the brokerage, it’s best to invest for the medium-to-long term.
Generally, stock markets tend to outperform other safer investment instruments such as fixed deposits or bonds in the long term.
What to do when markets crash?
Stock markets carry out occasional corrections, and this sends shockwaves among investors.
As a knee-jerk reaction to a stock market crash, investors try to liquidate their holdings and minimise their losses. However, it may not be the ideal thing to do. Stock markets correct themselves after a few trading sessions, and most scrips regain their lost value.
If this happens, those who hold their stocks see that their losses have been overturned after a few sessions, while those who sell their stocks will lose out.
Ideally, a stock market crash is a good time to invest in good quality stocks. Stocks of blue-chip companies, which generally outperform the other companies, can be purchased at a discount in a market crash.
It’s important to note that when a stock goes up or down, an individual doesn’t make a profit or loss until he sells his shares. Therefore, the gain or loss is only notional. If a $20 share trades at $35, the stockholder has a notional gain of $15. But it will only be realized when he sells his shares.
What is the total market value of all shares in the world?
In 2020, it was estimated that the total market capitalisation of all publicly traded companies in 2020 was about $93 trillion — that’s 93 followed by 12 zeros.
How many people are investing in stocks?
There are tens of millions of people, though the real number is hard to track as investment companies — pool money from smaller investors.
In 2020, 55% of adults in the US invested in stocks, down from the 2007 peak at 65%. As of 2021, the top 10 per cent of Americans owned an average of $969,000 in stocks. The next 40 per cent owned $132,000 on average. For the bottom half of families, it was just under $54,000.
In early 2020, India’s young population piled into the soaring stock market, adding 400,000 investor accounts each month, according to India’s market regulator. In 2021, that number has grown to about 2.6 million, about half the population of New Zealand.
What is the biggest risk in stock investing?
The biggest risk of investing in stocks is stock market volatility. On average, the stock market declines 10% from its high about every 11 months, 20% around every four years, and more than 30% at least once per decade. Because of that volatility, investing in stocks isn't for everyone.
What is a bear market?
A bear market is when stocks face prolonged price declines. It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment. Bear markets also may accompany general economic downturns such as a recession.
What is a market bull?
A bull is a stock market speculator who buys a holding in a stock expecting that in the very short-term it will rise in value whereupon they will sell the stock to make a quick profit on the transaction.
What do indices show. What is Dow, S&P500, Nasdaq, DFM, ADX, BSE, NSE?
A stock market index is created to closely track the performance of any particular aspect of the market. It is one of the key indicators that economists, investors, and others can use to monitor market performance in different ways.
Indexes are created to track items such as publicly-traded stocks, bonds, and consumer prices for common goods and services.
Most common indices from around the world
The Standard & Poor's 500 Index (known commonly as the S&P 500) is a barometer that tracks the performance of stocks of 500 of the largest companies across various industries in the US.
Stocks are chosen for the index primarily by capitalisation, liquidity, public float, sector and trading history.
The S&P 500 Index represents 80 per cent of the total value of the US stock market. In general, the S&P 500 Index gives an overview of the US market as a whole.
Russell 2000 tracks the performance of the 2,000 smallest publicly traded companies in Europe, Asia, Far East. Russell 2000 measures the performance of stocks in developed countries outside of the US and Canada.
The Dow Jones Industrial Average (DJIA) tracks the performance of 30 companies from different industries representing the largest and most widely held publicly traded companies in the US. Companies listed on Dow Jones are price-weighted and don’t change frequently.
In general, the Dow is known for its listing of the blue-chip companies with regularly consistent dividends.
It is one of the oldest, most well-known, and most frequently used indexes in the world. The DJIA represents about a quarter of the value of the entire US stock market, however, a per cent change in the Dow is not proportionate to the entire market plunge. Ideally, the Dow should not be used to represent sentiment in other areas of the marketplace.
Nasdaq is a heavy tech weighted index. It is the exchange on which technology stocks are traded. The Nasdaq Composite Index is a market-capitalisation-weighted index of all the stocks traded on the Nasdaq stock exchange. This index includes some companies that are not based in the US.
Nasdaq includes several subsectors across the tech market including software, biotech, semiconductors, and more. Although this index is known for its large portion of technology stocks, it does include some securities from other industries as well.
Sensex: BSE is India’s first listed exchange which was established in 1875. Over the years, the number of companies listed on the exchange rose to around 6,000. BSE's popular equity index - the S&P BSE SENSEX - is India's most widely tracked stock market benchmark index. It is traded internationally on the EUREX as well as leading exchanges of the BRCS nations (Brazil, Russia, China and South Africa). BSE Sensex consists of 30 top scrips from different sectors that form this index.
BSE has recently launched a special platform for trading in SME securities. It has also launched a free-float index - S&P BSE Sensex. BSE has a lot of other indices under various categories of Equity and fixed income.
Nifty: NSE began its operations in the year 1994. Nifty consists of 50 top companies from different sectors that form this index. NSE has a lot of other indices under various categories - broad market indices, sectoral indices, strategy indices, thematic indices and fixed income indices.
In the year 2016, NSE launched the Nifty 50 Index futures trading on TAIFEX. Nifty50 was earlier known as CNX Nifty. It was renamed Nifty50 in the year 2015.
As the age-old saying goes, take risks carefully, the bigger the risk, the bigger the fall. So tread carefully and invest wisely.