The stock market offers one of the biggest wealth creation opportunities. According to Alpha Architect, “ U.S. stock market investments increased shareholder wealth on net by $47.4 trillion between 1926 and 2019.” Moreover, the market’s performance has shown a consistent improvement: The market’s performance average over the last 10 years is 12.57%, whereas the performance average over the last 5 years is 16.43%.
These facts are indeed alluring, but you should also be aware of disheartening statistics, such as 57.8% of the stocks actually lost money and reduced shareholder wealth. Moreover, the wealth creation through stocks is highly disproportionate since the top 4% of the stocks accounts to 96% of wealth creation.
So, can you make money through the stock market? Absolutely. Can you do that by simply walking into the market? Absolutely not. A well-informed, strategic, and disciplined investor can make a fortune, while a naive optimist will be punished by the market. The first step towards being the former is to be informed about some fundamentals of the market.
Understanding Stock Ownership
Buying stocks, a friend, or a random YouTuber recommended? What exactly are these stocks? What is a portfolio? Many skip these, thinking its theory that they will never use, and they could not be more wrong.
Stock
A ‘stock’ is the fundamental unit of ownership of a company. So, when you buy a stock of a company, you are buying into the company’s ownership( a tiny part of the company), which gives you a claim on its assets and earnings. When the company performs well, you will benefit proportionally to the amount of stock you own, and when it underperforms, you will lose money, also proportionally to the amount of stock you own.
The stock exchange is the place where you can buy and sell the stocks of different companies. The major stock exchanges in the USA are the NYSE and the NASDAQ. Moreover, you can’t buy and sell directly; you will need an intermediary called a ‘brokerage’, which is what apps such as Robinhood, Fidelity, Webull, and Charles Schwab do.
Portfolio
A portfolio refers to a comprehensive account of all your financial assets, including stocks, bonds, mutual funds, ETFs, cash, and other equivalents. The main dashboard you see when you log into investing apps such as Robinhood and Fidelity is a snapshot of your portfolio. It tells you how much you own, how much of what you own, and the complete breakdown of your investments.
Such a representation of a portfolio helps you keep track of all your investments and gain insights about how your assets are performing live. Most often, people with a huge portfolio hire financial experts to manage it for them since handling highly diversified portfolios is a time-consuming task.
Dividends
A dividend is the profit shared by the company with the investors in periodic intervals. For example, if a company’s dividend is 1 dollar per share and you own 100 shares, you will receive 100 dollars as dividend income. Sounds good? But, most companies ( they reinvest it in themselves to accelerate growth) don’t pay dividends, only big and stable ones do. Moreover, the dollar per share value of such companies is often low; for example, Coca-Cola pays 0.51 dollars per share each quarter.
How Stock Pricing Works
Stock prices are not random numbers generated by chance; investing and trading are not gambling. The price of a stock at any given time reflects complex negotiations, trade, and supply quotations in real time.
Bid
A bid is the highest price a seller is willing to pay for a stock. That is, the bid is the amount the market is willing to pay you now if you want to sell your stock.
Ask
Ask is the lowest price at which a seller is willing to sell the stock. The ask is almost always higher than the spread, and this disparity between the bid and ask is termed ‘bid-ask spread’.
Stop Loss
Stop Loss is basically a safety net you can set up to mitigate your losses. It’s best understood through a practical example. Let’s assume that you bought stock for $100 per share. You don’t want to lose all of it in case the stock crashes, so you decide a percentage of maximum loss you are willing to suffer- say 20%. Now, you will be setting stop loss at $80. So, if the stock starts falling and hits $80, your broker sells your share and limits your losses to $20 per share.
From Learning Investing Fundamentals to Building Wealth
The distance between a profitable investor and a newbie whose capital gets wiped out often is the knowledge of the fundamental concepts. If your decisions are seasoned by the conceptual clarity of what exactly you are doing, you will eventually and invariably become profitable. The concepts we discussed here, such as stock, portfolio, dividends, bid, ask, and stop loss, are building blocks on which you can build the rest of your stock market expertise. We recommend that you learn further before testing the waters so that your early losses are affordable tuition, and not debacles.
