Investing 101 – Understanding The Stock Market Lingo

by Hank

Here are a few beginner-level terms that you should be familiar with in order to begin to understand stocks and how the stock market works.

Public Listing. All companies listed on the stock market are called public companies. They enter the stock market with an IPO (initial public offering) where they offer their shares to the public for the first time. After the IPO is completed, their shares can be traded on the secondary market from one seller to another private seller. Publicly listed companies are required by law to divulge details about their financial situation to the public. They have to publish their financial statements (Income Statement, Balance Sheet, and Statement of Cash Flow Statement) and make it accessible to everyone. You can look up any public companies filings on the SEC’s Edgar Database website. These filings make sure that there is no lying or cheating from the management and the results between different companies are comparable with each other. All statements have to be audited for accuracy and in accordance with the accounting laws by an external party.

Supply & Demand. The shares of stock which are bought and sold in the secondary market are traded at the price set by the laws of supply and demand. This means that the share which faces an increase in demand/decrease in supply will see an increase in its price and vice versa. However, supply and demand is not the only factor affecting price. In reality, a stock price is the intrinsic value of the company. According to classic finance theory, the price of a stock is the future cash flows of all the profits of that company including profits in the future and the probability of issuing dividends.

Margin Accounts. In addition to buying shares with cash through your stock broker, you can also buy shares on credit which are called margin accounts. This makes the investment more risky. As the share price falls, you can be asked to contribute more money into your brokerage account in order to keep your margin percentage at a set level. You may be forced to sell your stocks at an inopportune time as well if you are too far in the red on credit or margin.

Short Selling. Instead of buying a stock, you can sell it short before you actually own it. This basically means that you sell the stock today, without buying it first, and make a promise to buy it back at a future date which is hopefully at a lower price. So, you are borrowing the shares, selling them today at a high price, and buying them back at a lower price in the future. This way you will benefit if the stock price falls but will lose if it increases. Lately, a lot of short sellers have taken the brunt of criticism while the market falls, but short sellers are not to blame for market crashes. They are actually market makers stepping in to buy shares of companies when no one else wants them.

Brokerage Firms. You need to go through a brokerage house to buy shares as they have the permission/access to do so. The brokerage house charges a small commission on each trade. The commission might be fixed or linked to the value of the share. There are several good discount brokerage firms that you can use to purchase shares of stocks, shares of mutual funds, options, and other investments for as little as $7 per trade. Some of my favorite discount stock brokers are: Scottrade, Trade King, tradeMONSTER, OptionsHouse, OptionsXpress, and Zecco

These are just a few of the terms that everyone who invests should know. I hope that this is just a beginning of the review and hope to give you some more investing terms and definitions to add to your kit bag. Investing is a game of constant learning and growing. And, we all need to have a baseline of knowledge, but it is not hard.

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