by Joe Duffy

As one of the most widely held types of investments, stocks (or “equities” or “securities” or “shares”) are relatively easy to understand compared to other trading instruments.  The primary purpose of the stock market is to assist in capital formation.  Companies can either borrow money from bonds for expansion plans, acquisitions, research and development, or whatever they want to fund, or they can sell pieces of the corporation to shareholders, whether it’s an initial public offering (IPO) or an additional share offering.

Some things that are common to stock market investments:

  • US stock market trading is regulated by the Securities and Exchange Commission.  The Federal Reserve sets the minimum “margin” requirements.
  • Traders must put up a minimum of 50% of the price of the stock as a down payment to own the stock.  The balance is borrowed from the brokerage firm, and traders pay interest on the loan.
  • Traders wanting to go short must draw from an inventory of stocks held by a brokerage firm.
  • Stock markets normally operate with a specialist system with market-makers responsible for making markets in specific stocks.
  • The supply of shares for a company is fixed.
  • Stocks can be held indefinitely.  They do not expire.
  • Stocks usually have no limits on the movement of price or the size of positions, although there may be “curbs” on trading during volatile conditions.

Aside from the bull market at the end of the 1990s, the recent attraction of the stock market has been the number of instruments available for investors.  Since the introduction of the 401(k) and Individual Retirement Account plans in the early 1980s, millions of additional Americans have a personal stake in what happens in the stock market.

When momentum gets exhausted, this pattern pays out. To recognize the signs, click here.

Trading Individual Companies

One way to invest in stocks is to trade individual companies.  You can invest in the fate of individual companies in several ways:

Shares of the Company Itself

Stocks are shares of ownership in the assets, earnings and prospective direction of a corporation, which sells these shares to raise large sums of money for various purposes.  Common stock is the basic form of ownership that allows holders to vote for a board of directors and other company proposals.  Preferred stock is a different type of fixed-income ownership.

Individual stocks became one of the hottest investment areas during the bull market because of the potential gains with relatively low risk.  Because most individual investors are trying to buy, a shift to a neutral or bear market will cool off some of this investment interest.  This type of investing puts a big premium on picking the “right stock” from the thousands available.  You can choose from the traditional blue chip “value” stocks such as Johnson & Johnson or Hershey, to the high-flying technology “growth” stocks such as Amazon or Apple, to the more thinly traded and potentially risky penny stocks.

Individuals may prefer to purchase stocks on a cash basis – that is, paying the full amount of the value of the stock.  However, stocks are also purchased on “margin” – that is, purchased with a minimum of half of the current price in your account by borrowing the remainder from the broker and paying interest on the loan.  Stocks can also be sold short by borrowing shares from the broker and then buying them back later, presumably at a lower price, although brokerage firms generally do not encourage that practice.

Here is how a list of stock prices might appear on a computer screen and the significance of several key columns:

52-Week High/LowStockDivYldPEVol 100’sLastChg

52-Week High/Low: This puts the current price into perspective.

Dividend (Div): Amount of money paid quarterly by companies to stockholders for each share of stock owned.  This amount is multiplied by four to obtain the estimated annual dividend and may be the most important number for those seeking regular income.

Yield (Yld): Dividend divided by the stock price.

Price-to-Earnings (PE): Shows the relationship between the price of the stock and the earnings generated by the company in the current year.  Some prefer to look at the projected future earnings.  For most investors, the PE ratio will be the most important fundamental factor to watch as it distills key information about a company into one number, but it does not always tell the full story in assessing the value of a stock.

Stock Options

Instead of buying shares in the company, you can use options to buy or sell the right to be long or short the company’s shares at a specific price.  The key to this type of investment is the “right direction” at the “right time”.