Trade12 - Stock Market Basics

Stock Market Basics

If you’re considering an investment in the stock market and the mere thought of losing money worries you, then don’t invest. The stock market is a web of complexity that is not suitable for the novice investor. Nonetheless, if you do decide to invest, there are some points you should keep in mind to prevent losses and rather increase your chances of making more money.

five basics of the stock market:
how they work and what do they react as they do.

And so we begin.

Trade12 - Stock Market Definition

  1. “Stock Market” Definition

Investopedia defines it as the market in which shares of publicly held companies are issued and traded in two ways: through exchanges or over-the-counter markets. The stock market is also one of the most essential gears of a free-market economy, being known as the equity market, and offers companies with access to capital in exchange for giving investors a part of ownership in the said company.

Plainly put, it is a complicated system where shares of publicly-traded companies are issued, bought and sold—to buy the stock, hold it for a time, and then sell the stock for more than you paid for it. Investors who hold stock for a minimum of fifteen years are the ones who usually succeed in the market. Stocks are long-term investments; however, there are no guarantees.

Does it seem like it’s a scary pit meant for gambling? Probably not—unlike in gambling where you lose everything you have at hand, when you invest in stocks, you will either win or lose just an amount. It is rare to lose it all, except for the instance you invested in a company that went bankrupt.

Be sure the company you’re buying is worth owning. Unless you simply love risk, you should probably refrain putting too much of your money in one stock.

  1. The Stock Market is an Adversary Trading System

The stock market is a group of millions of investors with, of course, utterly contrasting views and opinions. This is due to the norm that when one investor sells a specific security, someone else must willingly purchase it. And since both investors cannot be correct, it turns to be an adversarial system. One investor will profit, and the other will experience loss. So it is important to become knowledgeable and familiar on the investment you want.

  1. Factors that Make Stock Prices Rise and Fall

The media, opinions of renowned investors, natural catastrophes, risk, supply and demand, the shortage and surplus of alternatives, and political and social unrest are included in the many factors that determine the direction of stock prices. Quite complicated, actually.

Combining these factors and the all the relevant information that has been circulated, it produces either a bullish or a bearish sentiment, and a corresponding number of buyers and sellers. If there are more sellers than buyers, prices will go down. And of course, prices would go up when there are more buyers than sellers.

Trade12 - The Stock Market is Unpredictable

  1. The Stock Market is Unpredictable

An example for this number: Stock prices have been surging for a couple of years now. Investors think that a correction will come and stock prices will fall. The dilemma is this:  nobody knows what will be the cause of the selloff or when it’s going to happen.

Read about: How to Conquer a Volatile Market.

This causes investors to watch by the sidelines, holding cash, and jump as soon as the opportunity presents itself. Those who are willing to jump in despite the risk are triggered by the low cash return and it creates unease to earn apparently nothing while watching stocks move upwards.

The stock market’s unpredictability makes it almost impossible to know when to jump in when you’re on the sidelines, or when to get out when you’re in. This brings forth three issues for an investor to take into consideration.

  • Understanding the point at which stock prices are valued practically and fairly.

Market activity determines the actual price of a stock. When the decision comes whether to buy or sell, the investor often compares a stock’s actual price to its fair value. Overvalued stocks tend to repel the investor, if he were to make a practical choice.

Now, what is a fair value and how do measure it? Preferably, it would be based on a consistent formula. But there are many ways to calculate the number. One solution is to sum up the value of a company’s assets on its balance sheet, excluding liabilities and depreciation.  Due to the nature of these methods yielding slightly different results, sometimes it’s hard to identify if a stock is overvalued, undervalued, or fairly valued.

An important reminder as well is that overvalued stocks don’t always trigger the investor to sell and eventually drag the price down. A stock can stay overvalued for quite some time. This is why it is tricky to make buy or sell decisions based on where the price is in relation to some moving average.

  • The event that will prompt a slump, or a trend reversal.

To put in a simpler note: no one can predict what will happen and come in the future to cause a disruption and reversal in the trend.

  • Understanding the human decision-making process.

Humans oftentimes use logic to analyze a situation, and let emotions rule us in action.

In making investment decisions, you must be able to process the significant data and cast a good decision, since there will be investors on the other side prepared to buy what you’re selling and vice versa. It is impossible to know everything you would need to know and process it without a hint of bias, however, and thus it prompts us to make sub-par decisions at times. This happens even with the most logical and critical people.

  1. The Best Time to Buy and Sell

Benjamin Graham, the father of value investing, once said, “The buyer of common stocks must assure himself that he is not making his purchase at a time when the general market level is a definitely high one, as judged by established standards of common-stock values.”

The answer as to when to buy or sell stocks is this: the best time to buy is when others are pessimistic, and the best time to sell is of course, the opposite— when others are active and optimistic. Deciding on this matter is very crucial.

It should be remembered that when buying, the chance of a high return is bigger if you buy after its price has tumbled rather than after climbing, though it is still recommended to remain cautious. Why be attentive? Let’s say the stocks of Company A plummeted by 40 percent. The first thing to do is to ask questions—why did the stocks drop as it did? Did other stocks in the same industry experience a decline as well, was it severe? Did the entire market fall?  Assuming the other stocks in the same sector did relatively well, it can be assumed that the problem lies with Company A. It’s wise to take on and follow a buy or sell discipline.

It takes years to become knowledgeable and well-versed in the field of financial markets and stocks. While it may seem like an unnecessary cost, but we recommend finding someone you trust and ask for their guidance. After all, diving head first into unfamiliar waters alone without any proper experience may actually be more expensive.

Best of luck to you, Trader!


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