The stock market is driven by supply and demand. The number of shares of stock dictates the supply and the number of shares that investors want to buy dictates the demand. It's important to understand the for every share that is purchased, there is someone on the other end selling that share (or vice versa). The main players in the stock market are the exchanges. Exchanges are where the sellers are matched with buyers to both facilitate trading and to help set the price of the shares. The stock market is really just like any other marketplace - it facilitates the exchange of goods between interested parties and works to reduce distribution costs and set prices.
There are two ways to invest in the stock market - directly or indirectly.
- Direct investment means buying individual shares which give you a stake in a PLC.
- Indirect investment involves a fund manager pooling together money from a number of investors and then using this large sum to invest in a whole range of shares. This sort of collective investment spreads the investors' risk and means that if one share drops in price, the overall value of the fund will be largely unaffected.
Additionally, because collective investment funds are run by professional fund managers, they allow individuals with only a relatively small amount of cash to get access to the kind of investment expertise which they would not normally be able to afford.
Only invest in shares or stock market funds if you can tie your money in for the long term. Investment advisers believe you should be prepared to invest for at least five years to smooth out short-term ups and downs on the markets.
Shares can be sold at any time but it is naturally better to sell them when their value is greater than that at which you bought them. This profit is known as ‘Capital Growth’ and it is subject to capital gains tax if is exceeds a particular threshold.
The art of stock picking
If you become a good stock-picker, you can increase your personal wealth exponentially. Take Microsoft, for example. Had you invested in Bill Gates' brainchild at its IPO back in 1986 and simply held that investment, your return would have been somewhere in the neighborhood of 35,000% by spring of 2004. In other words, over an 18-year period, a $10,000 investment would have turned itself into a cool $3.5 million! (In fact, had you had this foresight in the bull market of the late '90s, your return could have been even greater.)
Stock market tips
- Research individual stocks by reading annual reports, quarterly reports and other documents on file with the Securities and Exchange Commission.
- Invest in what you know. Consider the stocks of local companies with which you are familiar and in which you have confidence.
- Check out the holdings of some successful mutual-fund companies. If they are winning with particular stocks, perhaps you will too.
- Diversify. Avoid putting your money in just one or two stocks or, for that matter, in one or two industries.
- Use a discount brokerage to buy stocks if you are confident in your investment skills and have the time to do your own investing. You'll save on commissions.
- Buy stocks that you will feel comfortable holding for three to five years. Resist the temptation to dump a stock the moment its price drops a few percentage points. Give it a chance.
- If you don't have time to research and review stocks daily, try investing in a mutual fund account, at least to get started.
- Look for value. Use price-earnings ratios, usually reported in newspapers' stock tables, to compare a stock to industry norms before you buy.
- Don’t try to time the market. As tempting as it is to try, it is not possible to time the stock market. People have written millions of pages of research on this topic and NO ONE has ever found a legitimate way to determine its trends..
- Use cost averaging. By buying stocks on a periodic basis (like once a paycheck, once a month or even once a year), you will always be buying at an average price. If you try to time the market, you may be buying at a high or low valuation.
- Take taxes into account. When you buy stocks, try to hold them for more than one year so you get taxed at the long term capital gains rate, which is currently 18%. If you sell your stock before one year, you will be taxed at your ordinary income tax rate, which is almost always higher than 18%, sometimes twice as high.
- Invest as much as possible into tax-sheltered 401K, 403B and IRAs. By investing in tax deferred plans, you are able to invest money and not worry about the tax implications. With 401K and 403B plans, you get to invest your earnings before taxes, so the investment will grow on a higher base. For example, if you received a paycheck for $2,000 gross pay and taxes were taken out, you'd be left with only $1,200 or so to invest. The investment return on $1,200 could be substantial, but if you could invest that same $2,000 in a tax deferred account, you would be investing and earning a return on $2,000 instead of $1,200. Also, many employers offer matching investments that could make that $2,000 investment equivalent to a $4,000 investment. Put as much as you can into these tax deferred investments.
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