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What Causes Stock Prices To Change?

Stock prices change every day as a result of market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies. That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don't equate a company's value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding. For example, a company that trades at $100 per share and has 1 million shares outstanding has a lesser value than a company that trades at $50 that has 5 million shares outstanding ($100 x 1 million = $100 million while $50 x 5 million = $250 million). To further complicate things, the price of a stock doesn't only reflect a company's current value, it also reflects the growth that investors expect in the future. The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter). Wall Street watches with rabid attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. If a company's results surprise (are better than expected), the price jumps up. If a company's results disappoint (are worse than expected), then the price will fall. Of course, it's not just earnings that can change the sentiment towards a stock (which, in turn, changes its price). It would be a rather simple world if this were the case! During the dotcom bubble, for example, dozens of internet companies rose to have market capitalizations in the billions of dollars without ever making even the smallest profit. As we all know, these valuations did not hold, and most internet companies saw their values shrink to a fraction of their highs. Still, the fact that prices did move that much demonstrates that there are factors other than current earnings that influence stocks. Investors have developed literally hundreds of these variables, ratios and indicators. Some you may have already heard of, such as the price/earnings ratio, while others are extremely complicated and obscure with names like Chaikin oscillator or moving average convergence divergence. So, why do stock prices change? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know is that stocks are volatile and can change in price extremely rapidly.

The important things to grasp about this subject are the following: 1. At the most fundamental level, supply and demand in the market determines stock price. 2. Price times the number of shares outstanding (market capitalization) is the value of a company. Comparing just the share price of two companies is meaningless. 3. Theoretically, earnings are what affect investors' valuation of a company, but there are other indicators that investors use to predict stock price. Remember, it is investors' sentiments, attitudes and expectations that ultimately affect stock prices. 4. There are many theories that try to explain the way stock prices move the way they do. Unfortunately, there is no one theory that can explain everything.

Buying Stocks

You've now learned what a stock is and a little bit about the principles behind the stock market, but how do you actually go about buying stocks? Thankfully, you don't have to go down into the trading pit yelling and screaming your order. There are two main ways to purchase stock:

1. Using a Brokerage

The most common method to buy stocks is to use a brokerage. Brokerages come in two different flavors. Full-service brokerages offer you (supposedly) expert advice and can manage your account; they also charge a lot. Discount brokerages offer little in the way of personal attention but are much cheaper. At one time, only the wealthy could afford a broker since only the expensive, full-service brokers were available. With the internet came the explosion of online discount brokers. Thanks to them nearly anybody can now afford to invest in the market.

2. DRIPs & DIPs

Dividend reinvestment plans (DRIPs) and direct investment plans (DIPs) are plans by which individual companies, for a minimal cost, allow shareholders to purchase stock directly from the company. Drips are a great way to invest small amounts of money at regular intervals.

How to Read a Stock Table/Quote

Any financial paper has stock quotes that will look something like the image below:

Columns 1 & 2: 52-Week Hi and Low

These are the highest and lowest prices at which a stock has traded over the previous 52 weeks (one year). This typically does not include the previous day's trading.

Column 3: Company Name & Type of Stock

This column lists the name of the company. If there are no special symbols or letters following the name, it is common stock. Different symbols imply different classes of shares. For example, "pf" means the shares are preferred stock.

Column 4: Ticker Symbol

This is the unique alphabetic name which identifies the stock. If you watch financial TV, you have seen the ticker tape move across the screen, quoting the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. If you don't know what a particular company's ticker is you can search for it at: http://finance.yahoo.com/l.

Column 5: Dividend Per Share

This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends.

Column 6: Dividend Yield

This states the percentage return on the dividend, calculated as annual dividends per share divided by price per share.

Column 7: Price/Earnings Ratio

This is calculated by dividing the current stock price by earnings per share from the last four quarters. For more detail on how to interpret this, see our P/E Ratio tutorial.

Column 8: Trading Volume

This figure shows the total number of shares traded for the day, listed in hundreds. To get the actual number traded, add "00" to the end of the number listed.

Column 9 & 10: Day High & Low

This indicates the price range at which the stock has traded at throughout the day. In other words, these are the maximum and the minimum prices that people have paid for the stock.

Column 11: Close

The close is the last trading price recorded when the market closed on the day. If the closing price is up or down more than 5% than the previous day's close, the entire listing for that stock is bold-faced. Keep in mind, you are not guaranteed to get this price if you buy the stock the next day because the price is constantly changing (even after the exchange is closed for the day). The close is merely an indicator of past performance and except in extreme circumstances serves as a ballpark of what you should expect to pay.

Column 12: Net Change

This is the dollar value change in the stock price from the previous day's closing price. When you hear about a stock being "up for the day," it means the net change was positive.

Quotes on the Internet

Nowadays, it's far more convenient for most to get stock quotes off the Internet. This method is superior because most sites update throughout the day and give you more information, news, charting, research, etc. To get quotes, simply enter the ticker symbol into the quote box of any major financial site like Yahoo Finance, CBS Marketwatch, or MSN Moneycentral. The example below shows a quote for Microsoft (MSFT) from Yahoo Finance. Interpreting the data is exactly the same as with the newspaper.

The Bulls, The Bears And The Farm

On Wall Street, the bulls and bears are in a constant struggle. If you haven't heard of these terms already, you undoubtedly will as you begin to invest.

The Bulls

A bull market is when everything in the economy is great, people are finding jobs, gross domestic product (GDP) is growing, and stocks are rising. Things are just plain rosy! Picking stocks during a bull market is easier because everything is going up. Bull markets cannot last forever though, and sometimes they can lead to dangerous situations if stocks become overvalued. If a person is optimistic and believes that stocks will go up, he or she is called a "bull" and is said to have a "bullish outlook".

The Bears

A bear market is when the economy is bad, recession is looming and stock prices are falling. Bear markets make it tough for investors to pick profitable stocks. One solution to this is to make money when stocks are falling using a technique called short selling. Another strategy is to wait on the sidelines until you feel that the bear market is nearing its end, only starting to buy in anticipation of a bull market. If a person is pessimistic, believing that stocks are going to drop, he or she is called a "bear" and said to have a "bearish outlook".

The Other Animals on the Farm - Chickens and Pigs

Chickens are afraid to lose anything. Their fear overrides their need to make profits and so they turn only to money-market securities or get out of the markets entirely. While it's true that you should never invest in something over which you lose sleep, you are also guaranteed never to see any return if you avoid the market completely and never take any risk, Pigs are high-risk investors looking for the one big score in a short period of time. Pigs buy on hot tips and invest in companies without doing their due diligence. They get impatient, greedy, and emotional about their investments, and they are drawn to high-risk securities without putting in the proper time or money to learn about these investment vehicles. Professional traders love the pigs, as it's often from their losses that the bulls and bears reap their profits.

What Type of Investor Will You Be?

There are plenty of different investment styles and strategies out there. Even though the bulls and bears are constantly at odds, they can both make money with the changing cycles in the market. Even the chickens see some returns, though not a lot. The one loser in this picture is the pig. Make sure you don't get into the market before you are ready. Be conservative and never invest in anything you do not understand. Before you jump in without the right knowledge, think about this old stock market saying: "Bulls make money, bears make money, but pigs just get slaughtered!"

Conclusion

Let's recap what we've learned in this tutorial:

Stock means ownership. As an owner, you have a claim on the assets and earnings of a company as well as voting rights with your shares.

Stock is equity, bonds are debt. Bondholders are guaranteed a return on their investment and have a higher claim than shareholders. This is generally why stocks are considered riskier investments and require a higher rate of return.

You can lose all of your investment with stocks. The flip-side of this is you can make a lot of money if you invest in the right company and exercise discipline in your trades. For more on trading risks and rewards, and how to leverage the market, visit sstpi.com.

The two main types of stock are common and preferred. It is also possible for a company to create different classes of stock.

Stock markets are places where buyers and sellers of stock meet to trade. The NYSE and the Nasdaq are the most important exchanges in the United States.

Stock prices change according to supply and demand. There are many factors influencing prices, the most important of which is earnings.

There is no consensus as to why stock prices move the way they do. But you can still profit from the price movement if you have the right strategies in place.  To read more about stock momentum and trend analysis, visit momentumtrend.com.

To buy stocks you can either use a brokerage or a dividend reinvestment plan (DRIP).

Stock tables/quotes actually aren't that hard to read once you know what everything stands for!

Bulls make money, bears make money, but pigs get slaughtered!

This tutorial can be found at: http://www.investopedia.com/university/stocks/

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