Stock markets, and how stocks are tradedAs of 2014, an estimated 51% of American families owned stock. That’s a whopping 60 million families! The 60 major stock exchanges have a total value of US $ 69 trillion. With technology making rapid strides, online trade in stock market is rising steadily, for e.g., in the spring of 2017, an estimated 15.79 million people used online stock trading services in the United States alone. Knowing how to invest in stock market online is becoming increasingly important for people looking to increase their wealth.

What are stocks, and what are the different types of stocks?

A stock is a share in the ownership of a company, but in a limited manner. A shareholder can vote in shareholder meetings, receive dividends from the profit of the company, and sell shares to someone else. The stock holders don’t own the company, rather shares issued by the company. Company’s properties are legally separate from the shareholders property, which limit liability of both parties. A bankrupt company may be forced to sell its assets, but the shareholder can’t be asked to sell her assets. Similarly, if a shareholder is bankrupt, she can’t sell company’s assets to pay off her debts.

The shareholders owing majority of the shares of a company have higher number of votes, and can indirectly influence its direction by appointing its board of directors. For common shareholders, what matters more is a share of the company’s profit, and the value of a company’s stock depends on the profit it makes. Larger number of shares mean more profits; however, some companies don’t pay dividends, rather reinvests profit into the company to fund its growth. This is called ‘retained earnings’.

Companies issue stocks, which are also called equity or equities, to raise fund from the market. When an investor buys shares directly from the company, it’s called ‘primary market’, and if the share is bought from another shareholder, then that market is ‘secondary market’.

While companies can also borrow money by issuing ‘bonds’, they are forced to repay the creditors in the event of a bankruptcy, whereas the shareholders are last in the queue to receive payment in such events. Hence, for the investors, stocks are riskier than bonds, and consequently carry higher return.

When a company is founded, typically owners and early investors hold all shares, and at that time both the company and shares are ‘private’. Such shares are harder to exchange. However, when this company wishes to raise more funds for expansion, it can conduct an ‘Initial Public Offering’ (IPO) and sell the shares in the market. Such a company, and those shares, are then ‘public’.

Stocks can also be categorized as ‘common’ or ‘preferred’. A stock representing a claim on the profit, and a voting right, is a ‘common’ stock. Over the long term common shares yield higher returns, but also carry a higher risk, because the invested money is lost if the company goes out of business. Preferred stocks, on the other hand, has a guaranteed fixed dividend, but no voting right is offered.

Stock markets, and how stocks are traded

Once a company and its shares are public, the shares are traded in secondary markets called ‘stock markets’. These markets can be physical locations where stocks are traded on the floor, however, stock exchanges are increasingly becoming electronic, where trading is done electronically via computers on a network.

First stock markets emerged in European port cities or trading hubs like Antwerp, Amsterdam, and London. Stock markets appeared in the USA in the late 18th century. The oldest was the Philadelphia Stock Exchange (PHLX), while the most famous is the New York Stock Exchange (NYSE).

Modern stock markets are characterized by the regulations and professionalism, where buyers and sellers have assurance that the transactions will be conducted at fair price, within reasonable time. Major stock exchanges have stringent criteria to list a company that focus on their value and profitability. In matured markets, stock exchanges are self-regulatory organizations (SROs), and they have power to create and enforce industry regulations and standards. They stress on protecting investors through rules based on ethics, transparency and equality. However, there are also loosely regulated over-the-counter exchanges, called ‘bulletin boards’ (OTCBBs). They list companies that can’t meet stringent regulatory requirements of major stock exchanges, and hence OTCBBs are riskier.

The most common way to trade stocks is an auction, where the buyer places a ‘bid’ mentioning the price at which she wishes to buy, and the seller places an ‘offer’ indicating the price at which she would sell. A trade is made when a bid and offer match.

The trading process first involves getting a stock quote, which includes information like current bid, offer, the last price that traded for the stock, number of shares traded, and the company symbol in the stock exchange. In modern days, stock quotes obtained online may also include charts and interactive tools, and online quotes are often real-time quotes.

Individuals can engage licensed stock brokers, who make the actual trade. While ‘full-service’ brokers offer a comprehensive suite of services, discount brokerage firms offering limited services may be more suitable for budget-conscious clients. With advent of electronic trading, online brokerage firms offer a range of services, often at very low price.

Trade orders can be of different types, for e.g.:

  • A market order is when buying or selling happens at the best available price. It doesn’t guaranty a price, but guarantees the number of share specified will be transacted.
  • A limit order is when the price at which the trade should happen is specified. This can guaranty the price, but the volume can’t be guaranteed, because it will depend on availability. If the volume is also important for the trader, then the limit order should be designated as ‘all-or-none’ (AON), and this will ensure no share will be bought or sold unless the price point is matched.
  • Traders, when wishing to limit their loss, can use a ‘stop order’, which is also called a ‘stop-loss order’. The trade is executed only when the stock price reaches a level.
    Traders with advanced level of knowledge and experience sometimes use specialized trading practices such as ‘margin trading’ and ‘short selling’. There are higher risks involved with these, and some brokerage firms may not offer these services. Margin trading allows traders to buy shares more than the amount of cash in their accounts. Short selling involves a trader borrowing shares and selling them, with the hope of buying them back in future at lower price.
  • Traders, in addition to following the prices of the shares they hold, also follow the movement of stock indices (also called indexes), which are aggregate prices of a set of different stocks. The movement of the index is determined by the movement of individual stocks. An example is ‘Dow Jones Industrial Average’ (DJIA). There are also market cap-weighted indices, believed by experts to be better indicators of the stock market, an example of which is ‘S&P 500’.

Prices in the stock market change every day, based on new information received about companies that are listed on the stock exchanges. Different traders have differing expectations, and they buy or sell at different prices based on their expectations. When optimism about the economy dominates, due to positive news about the economy, prices increase, and it’s called a ‘bull market’. On the other hand, when negative news about the economy dominate, pessimism pervades the stock market and prices take a downturn. Such a market is called a ‘bear market’.

Online stock trading

Technological advances over the past two decades have brought share market to our desktops and mobile phones. Online stock trading is increasingly common in matured markets and emerging markets alike. Using the brokerage firm’s website or mobile app, you can now buy stocks online, and sell them, with a few clicks. The online traders also enjoy the benefits from the speed at which the transactions and settlements are done, without worrying about paperwork.

Online trading, also known as electronic trading or etrading, is a method of trading stocks electronically, via electronic communication networks (ECNs). Examples of such virtual marketplaces are NASDAQ and Globex. While online stock trading is generally smooth, there are occasional glitches. In the US, most retail trading is now online.

Buying and selling stocks online require the following

  • Access to a computer and reliable Internet connection, or a smartphone and a mobile data connection;
  • The trader needs enough money to open an account;
  • The trader should have a reasonable financial history;
  • There are many online brokerage services available both on desktop and mobile, and the trader needs to choose one suitable to her requirements.

However, the most important requirements for a successful stock trader including online trader, are the knowledge of stock trading, understanding different types of trades, financial discipline, an in-depth understanding of the trading processes, and knowledge about the regulatory regime.

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