An Individual Retirement Account (hereafter called an IRA) is one of the biggest gifts that the government will ever give to you, so stop putting it off and accept Uncle Sam’s present to you. IRAs are a special type of account that allows you to save for your retirement with special tax privileges. Since the money that you deposit into an IRA account can be invested in many types of vehicles, the IRA is a great way to invest and save money on taxes at the same time. (Read More…)

Mutual funds are a collection of investments owned by a group of investors that have pooled their money together. The capital can be invested in stocks, bonds, money markets, and many other types of securities, including other mutual funds. (Read More…)

Simply put, stocks are small pieces of a company that represent ownership of the company. Commonly known as securities, they have been traded on stock markets for many years. Stocks and stock trading are easily misunderstood, even among some people that already call themselves stock traders.

Types of Stock

Common Stock

When referring to “stocks,” most people are speaking of common stock since the majority of all stock is classified as common stock. Each share of stock represents a piece of the company, and therefore each stockholder is a partial owner of the company. As a partial owner of the company, each shareholder also controls 1 vote per share at shareholder meetings.

Classes of Stock

Some companies have multiple classes of stock, such as “Class A” and “Class B” shares. Usually the difference between the classes of stock is the voting rights which the shares hold. For example, a company may issue class B shares with 5 votes per share, and class A shares with 1 vote per share. Although many companies only issue common stock, it is important to know whether the company issues different classes of stock.

Preferred Stock

Preferred stock is sometimes confused with being a class of stock, but preferred stock is a little different. Preferred stock is superior to common stock (or any class of stock) and takes precedent over common stock in certain situations. Preferred stockholders receive a dividend that is usually much higher than the common stock dividend. They are also entitled to the assets of the company if the company files for bankruptcy, whereas common shareholders are not.

Stock Trading

Stock Markets/Exchanges

Stocks are traded on stock markets, or stock exchanges. In the United States, the three major markets are the New York Stock Exchange (NYSE), the NASDAQ stock market, and the American Stock Exchange (AMEX).

The NYSE and the AMEX are both listed exchanges where transactions still take place on the trading floor. Market professionals, who are called “specialists,” act as an auctioneer for certain stocks. They are responsible for matching buyers and sellers together and ensuring that the orders do not become unbalanced (keeping the number of buy orders approximately equal to the number of sell orders).

The NASDAQ market is quite different; it is an “Over the Counter” market where brokerages act as “market makers” to buy and sell stocks directly over a centralized computer system. Instead of matching buyers and sellers, market makers actually keep an inventory of stock, so that they can purchase or sell shares directly when orders are placed (sometimes, but very rarely, market makers match buyers and sellers). For this reason, the volume (volume is the number of shares traded that day) numbers are misleading when comparing to NYSE volume numbers because the NASDAQ will count the transaction twice. For example, when trading buying 10 shares in the NASDAQ market, a market maker would purchase those ten shares from a seller, then sell 10 shares to you and the volume would be 20. On the NYSE, a specialist would match the buyer and seller and only one transaction of 10 shares would be made, and the volume would be 10.

Stock Price: Bid, Ask and Spread

Stock prices are never set; the actual stock quote lists the price of the last transaction that took place.

The bid price is the price that a buyer is offering to pay, while the ask price is the price that a seller is willing to sell at. Naturally, the ask price is always a little higher than the bid price. The difference between these prices is called the spread. The spread is kept as profit for the specialist and to pay other trading fees.

Other Useful Terms to Know

Volume: The number of shares traded that day for a particular stock, or the entire exchange as a whole.

Commission: The fee that a brokerage charges you for a trade.

Portfolio: The stocks/investments than an individual owns.

How to Buy Stocks

Stocks are almost always purchased through a brokerage. Brokerages vary widely in the level of services they offer and the commissions they charge.

A full service brokerage will offer many services, investing advice, and will even completely manage your portfolio for you, all for a hefty fee.

Discount brokerages offer less services, and usually never offer investing advice, but they also charge low commissions (about $7 a trade, or even as low as $4). If you are serious about learning to pick stocks yourself, I highly recommend finding a discount brokerage.

You will have to deposit a certain amount of money into your brokerage account to begin trading; the amount varies by brokerage, but some minimums are as low as a few hundred dollars.

Market Order

A market order is when you tell your brokerage to buy X number of shares of XYZ company. If you place this order you will pay the current asking price.

Limit Orders

A limit order is where you tell your brokerage to buy X number of shares of XYZ company, at a limit price of (for example) $35.50. This means that you will not pay more than $35.50 (actually, you will probably only pay $35.00, no less). If the asking price is more than $35.50, your order will not be completed immediately. The specialist/broker will hold your order until the asking price falls to your limit price, or until the market closes. If the asking price falls to $35.50, your trade will be executed. Since this order is a little more advantageous for the trader, commissions are usually a little bit higher for limit orders.

Stock Shorting

Shorting stocks is a way to profit from a market downturn. The normal strategy of stock trading is “buy low, sell high,” but in stock shorting the basic strategy is “sell high, buy low.” Yes, you can actually sell stock when you do not own it! But you are obligated to purchase the same amount of shares of stock at a later date. So therefore the purpose is to sell now and buyback the stock later, after a downturn in the stock price.

Stock Options

Stock options will be discussed in detail in a future article, but without going into great detail the basic idea is that when purchasing stock options you are purchasing an opportunity to buy (or sell) the stock. You do not actually own the stock unless you execute the option.

Buying on Margin

“Margin” is another term for loan. When buying on margin, your brokerage is lending you the money to buy stock. They are also charging interest on the loan, and they reserve the right to sell your stock if they think the load is in jeopardy, a “margin call.” Even though using margin to purchase stocks increases the amount of stock that you can buy (and possible profits), the combination of risk and the interest accumulating against me is the reason why I personally do not use margin to buy stocks.