A Primer on the Stock Market

There are few prices followed as widely and closely as the price of stock. In this section we are going to answer a number of questions concerning stock. As a jump start to the work you may want to visit the e-trade site where you can get some background information as well as access to a stock market game.

• What are stocks?
• Why would you own them?
• How do you make money owning stock?
• Where are the stocks bought and sold?
• How do you read stock market information?
• What are the stock market indexes?
• How do you account for inflation?
• What are mutual funds?
• How do you follow the stock markets?

Corporate stock is an equity instrument providing the holder with a share of ownership which includes voting rights in the issuing corporation corporation. Stated somewhat differently, a corporation sells a piece of paper that gives the holder of the paper a share in the ownership of the company, which in turn gives the holder the right to vote on company policies.

Why would you own stock?

It is generally not for the ownership right. The reality, though is quite different since companies usually issue thousand or millions of shares so one vote is as close to meaningless as you can get. There are situations, however, where BIG investors control enough of the shares to gain possession of a controlling vote and then ownership has real meaning. In recent years it has been the pension funds and mutual funds that have received the most press for the rapid growth in their holdings of corporate stock and the ability of the big ones such as TIAA and Fidelity to have gained some influence in the corporate board room.

If you are not going to be able to control the company, why would you buy a piece of it? The answer is simple enough; investors buy stocks because they think that they can make money by doing it, and the more money they think that they can make, the more they will buy.

How do you make money owning stock?

In theory there are two ways you can make money when you buy stock. First, you can earn dividends on the stock. A dividend is similar to interest on a savings account. Each firm decides how much to pay the owners of their stock. For example, if you bought one unit of J&T stock for $200 and the company paid a dividend of $16.90, then you would be earning 8.45% [200/16.90] on your investment. If you owned 100 shares of stock you would expect to earn $1,690 in dividend ‘interest ‘ for the year. To determine whether this was a good investment, you would compare it with the return on other investment possibilities. For example, if interest rates on savings accounts were 6%, then the J&T stock offers you a better return on your money.

The second way to profit from your stock purchase is to buy the stock at a low price and sell it at a high price, the secret to gains in any market. But how do you forecast price changes and where do you get information on the price of stock? We have already seen the answer to the first of these — it is in shifts in supply and demand. You would want to buy stock before there was an increase in demand or a decrease in supply. This is where insider information comes in. If you had some information about a company before the information got to the street, then you would be able to act on that information before others. If it were good news, you would want to buy and then wait for other to act when they received the news. If they reacted as you would have expected, they would have increased their purchases of the stock which would drive up the price of the stock that you owned. Now let’s look at where the stocks are bought and sold.

Where are the stocks bought and sold?

The market where the price of stock is determined is called the stock market. The most famous is the New York Stock Exchange where shares of many of the country’s largest corporations are exchanged. If you want to buy stocks in a younger company with national recognition, then you might very well find the stock listed on NASDAQ, while the stock in a smaller, local company would be listed in a regional market. All of these markets are secondary markets. markets where existing financial assets are exchanged.

In addition to these domestic exchanges, there are also a number of international exchanges that gained notoriety in 1997-98. In the 1990s American investors were increasingly moving their investments overseas to tap into the growth that was taking place in places such as Asia and Latin America. In 1997, however, the stock market in Thailand dropped precipitously which triggered a chain reaction — a modern version of the domino theory. As investors bailed out of foreign stocks, the prices in other South East Asian began to fall and then the contagion spread to Latin America and prices plummeted there. Now we will turn our attention to individual stock prices and the stock market indexes that provide a guide to the performance of the entire market.

How do you read stock market information?

Once you know which market a particular stock is traded in, you can follow it in the Wall Street Journal (WSJ) or on many of the stock quote web sites. [CNN. Alta Vista. Yardeni. Yahoo ]. You may also want to check out our own index .

What you will find is a summary of the activity in a particular stock for a given day. This will include information on price (actual price, change from previous day, range in prices over the past year), the volume of trades, and expected dividend earnings. In the WSJ the data are presented in a table that looks very much like the following.