In this lesson, you will learn:
What is the stock market?
Everyone seems to have some sort of idea about what stocks and shares are, but let's just be clear with some of the terminology. A stock or share represents ownership in a piece of a company. When you own a stock, you own a small piece of a much larger company. When you see stocks bought and sold on the stock market, you are watching people buying and selling their ownership shares in different companies.
The stock price of a company is the current market price of a single stock in that company. Every minute, thousands and millions of these stocks are traded on a stock exchange, such as the New York Stock Exchange (NYSE) or the NASDAQ. Buyers put in a bid price, or a price they are willing to buy the stock for, while sellers put in an ask price, or a price they are willing to sell the stock for. When you're trading with a stock broker, you can choose the maximum bid price you're willing to buy a stock for or the minimum ask price you're willing to sell a stock for. The stock exchange brings buyers and sellers together and settles the transaction whenever a buyer and seller have a matching bid and ask price, all in a matter of milliseconds. The "current" stock price usually quoted is simply the last trade price at which a buyer and seller agreed to complete a stock trade, which essentially represents what the stock market thinks the stock is currently worth.
What are some of the key terms?
The number of stocks of a single company being traded over any period of time is known as its market volume. Any unusually large increase in volume is a sign that people are currently trading the stock quite heavily, based on news or information about a company.
The market capitalization of a company represents its total value as determined by the stock market. You can calculate market capitalization by multiplying the current stock price of a company by the number of outstanding shares, or the number of stocks that the company has issued. The market cap of a company tells you its size, and people invest in different sized companies based on their investing style. As a general rule, larger, more established companies have less volatility in their stock price, but also less room to grow, while smaller, newer companies have greater volatility but greater potential for growth.
Market capitalization = Current Share Price x Outstanding Shares
The lowest and highest price that a stock has traded for on any particular day is known as its day range. The lowest and highest price a stock has traded for in the past year is known as its 52-week range. This range quickly gives you a picture of how much the stock price of a company has fluctuated in the past year.
Below is a reference chart you can use to find the information you're looking for when looking up companies on the WealthLift Stock Research page
Why do people invest in stocks?
So why do people invest in the stock market? Just like buying and selling any good that fluctuates in price, you can make money as the stock price of a company stock rises, creating capital gains, or an increase in the value of your assets, which allows you to grow your wealth. What differentiates stocks from other kinds of assets (cash, gold etc.) is that companies generate earnings. At the end of the day, assets are only worth what they can generate in future income. Companies provide goods and services and therefore generate profits, which means they continuously create income. Other income generating assets include real estate and bonds, which generate rent and interest respectively. These assets are contrasted with an asset like gold, which can serve as a safe haven against risks like inflation, but does not generate any income and therefore cannot grow significantly in real value over any long run time frame.
Obviously, companies take on an amount of risk in generating their profits – everything from guessing what consumers will want to buy to natural disasters to securing credit to finance their businesses. People who own stock in companies are therefore compensated for this risk in the form of much higher returns on their money, as compared to safer assets like savings and government bonds. This extra return-on-investment is known as the risk premium.
Taking a look at the chart below, we see the returns on an investment of $10,000 between 1964 and 2010 in four different types of assets: stocks, Treasury bonds, traditional bank savings deposits and gold. By 2010, an investment in stocks had turned into $714,925, as compared to $405,057 for gold, $220,619 for Treasury bonds and just $172,537 for a savings account.
Historical Stock, Treasury bond data: Federal Reserve of St. Louis
Historical Gold price data: Kitco.com historical gold charts
Historical CD Savings rate data: Federal Reserve Historical 6-month CD interest rates
While bonds and savings generate some return, and gold holds its value well over time, none of these other assets generate real earnings because none of these other assets actually generate profits from providing a good or service. Looking at the chart, we can see that compared to these other assets, stocks are more volatile, with significant swings both up and down over a period of months and years. These short term swings are the reason why even experienced investors continue to hold some of their wealth in assets other than stocks, such as cash and gold, in order to preserve their wealth during times of stock volatility, in what is known as diversification.
However, even with such swings, experienced investors know that this short term volatility is rewarded handsomely with much higher long term returns. Significantly, in the long run, inflation causes savings accounts and other “safe” assets to make you poorer relative to what you can actually buy, or produce negative real returns.
The significant real returns you can make through investing in stocks are the reasons why stocks are a crucial ingredient in anyone’s long-term financial portfolio.
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