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Wednesday, October 21, 2009

A Complete Amateur's Quick and Dirty Guide to the Stock Market

As many of you know, I was a technology major in college - not a finance or business major. But, I've bought stocks, and I've made money in the stock market. I have actually read a book or two about it. While I'm not an "expert," I feel perfectly qualified to offer the following information. It seems like something my friends might want to know about in these trying times.

First, the basics. Stocks are shares in companies which choose to be publicly traded. When you buy a stock, you own a part of a company. It's a very, very tiny part, but you're in there even if you own just one single share. Stocks are sold and bought on the stock market. There are actually several "stock markets," with the NY Exchange being the best known. The NY Exchange started under a tree at the end of Wall St. about 200 years ago, which has absolutely no bearing on anything but it's sort of interesting to think about how much things have changed.

Companies pretty much decide how much they will charge for a share of stock at first. After that, the price of a share of stock in any company is determined primarily by conjecture, mob mentality, and wild assed guessing. Really. There is some but very little correlation between the price of a share of stock and it's actual value. Occasionally, there is no correlation at all.

The value of a share of stock should represent how much money the company is likely to make over time. Let's say XYZ Co. Inc. has 100 shares of stock owned by various investors. Let's also say the company makes $100,000 profit this year. At the end of the year, that $100,000 would theoretically be split equally and each share of stock would earn $1000. If you owned 5 shares, you'd get $5000 in dividends. If XYZ invented a new product and expected to make $200,000 next year, the value of their stock would increase. If XYZ hired a complete idiot to run the company, the value of the stock might decrease because people would expect earnings to go down next year.

There are two ways to make money in the stock market: 1) Buy stock in good, solid companies which will earn profits consistently and hold onto these stocks for life. Every year, you'll get a nice dividend check in the mail. Or, 2) Buy stocks when their price goes down for whatever reason and sell them when the price goes up. It helps to have some idea of what might cause a stock price to go up or down. If you can figure that out, you're better than most Wall Street pros.

Wall Street people are very much like paranoid lemmings. If one fund manager decides to sell off ten-thousand shares of XYZ, Inc. tomorrow, other fund managers will likely assume that something is wrong at XYZ, Inc. and start selling their shares. The price of XYZ stock goes down. If somebody with some sense happens to be around to buy up the shares, the price will stabilize. But, then other investors may decide that XYZ shares are "hot" and start buying them up, causing the price to shoot up. And, so it goes. Day in and day out.

Sometimes stocks are bought and sold with the intent of affecting their share price. Sometimes information about a company is deliberately publicized to drive share prices up. That's what the Enron scandal was all about. With that sort of stuff going on, it can be very hard for Joe Middleclass to make good buy-sell decisions. Hell, that sort of stuff makes it hard for investment bankers to make good buy-sell decisions. But, even Joe M. knows that Wal-Mart is going to be in business for a long time.

So, my advice to anyone thinking of getting into the stock market (and this may be a very good time to do that if you have some money to invest): buy stock in good, stable companies that will continue to thrive in a sluggish economy. If the price goes down, buy more shares. Hold onto them until you don't need the dividend income any more. Or, if you're just not sure about all this, stick with managed funds where somebody else is getting paid to figure out what to buy or sell.

A side note (purely my opinion): When management of a company decides that Wall St. investors are more important than employees, you end up with a typical corporate sweat shop that treats its employees like crap. This is why I recommend buying stock in the company you work for - the profits resulting from having your pay cut, losing your bonus, getting no OT, and paying increased insurance premiums should come back to you in the form of dividends.

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