Simple guide to the stock market, trading & investing
Every day in the car, on the radio I hear about the stock market. This was all a blur to me and I didn’t really understand what they were going on about, and quite frankly, I didn’t care either. Why is this thing so important that we must hear about it on the radio, on newspapers and on magazines? Well, hopefully after you’ve read this article you will see its importance. I can’t say I know everything about the stock market, investing, and trading — but I wanted to share the very basics. The cracks of things, the things that you need to know.
This especially applies to you if:
- You want to be an entrepreneur one day
- You want to invest in stocks one day
- You are looking to understand stocks, investing, trading, indexes & more
- If you want to be wealthy or rich one day (Wealth is usually stored in stocks)
You probably know this guy, Warren Buffet. He’s an ordinary guy, except for the fact that he is the 4th wealthiest person alive right now. Well at least according to Forbes (see note 1). He has a net worth of $71,5 billion. He doesn’t have all that money stored in a bank account somewhere, hidden in his lawn, hidden under his bed or anything like that. This wealth is in assets, which include stocks. In order to understand stocks let’s look at the example of a business.
Let’s say I start a business named ‘Joja Retailers.’ I sell sneakers. Now I get a bit of money from some family members and an angel investor (an individual who provides capital for a start-up). My business is doing well but now I want to expand and build more stores in different locations across South Africa. I can enlist my company on the JSE (Johannesburg Stock Exchange) in what is called an IPO (Initial Public Offering).
- An IPO is the very first sale of a stock issued by a company on a public market, which essentially means that your company is being transformed from being privately owned to being publicly owned. This is known as the company ‘going public.’
- A stock exchange/ stock market is just a market where stocks are bought and sold. In South Africa, the main one is the JSE. In the United States, you get the NYSE, Nasdaq, and others. Each country has its own stock exchange(s)
So as soon as Joja Retailers goes public, Joja Retailers will enlist a certain amount of shares for sale available to the public. Now people can buy shares in my company at a certain price per share (e.g R6 per share). When they do so they become a shareholder/ investor in my company. I can now take the capital received from the sale of these shares and go expand my business. If my business continues to grow and do well, the share price for Joja Retailers will increase (e.g from R6 to R8). Then when a shareholder decides to sell their shares at that moment (when the share price is sitting at R8) they will make a R2 profit for each share they own. So everyone is happy, I get the money I need to expand and the shareholders get a slice of the profit.
But of course… It isn’t that easy and straight forward, or everyone would be rich and wealthy. Share prices fluctuate and are usually unstable. It is not guaranteed that you will make a profit, the share price for Joja Retailers might drop after you purchase the shares then you make a loss when you sell the shares. People try and predict how a share price is going to do in the future but there is no way you can be 100% certain. For example, a company might be doing very well and their financial statement looks good, then the CEO is caught in an affair scandal and the share price goes plummeting. There is no way anyone could have predicted this unless you were secretly stalking the CEO’s movements. Or even on the note of financial statements, maybe a company lies on their financial statements (like Steinhoff overstated their profits) then when the company is caught their share price plummets. So there are many uncertainties and risks associated with stocks but that is the name of the game. The profit you receive is the reward you get for the risk you take when you buy shares.
The possibility of future payout is what drives investors to take that risk and invest in the business.
Key Concepts
Stocks: A collection of shares of a single company or multiple companies.
Dividends: Money which is paid out of a companies profits or reserves to shareholders, usually frequently (e.g annually).
So they way dividends work are as follows. Let’s say Marylin owns 150 shares in Joja Retailers. Joja Retailers decides to declare a 30 cent dividend. So Marilyn can work out how much she will receive like this:
150 shares x 30 cents = 4500c 0r R45 Mature companies with strong cash flows are more likely to issue dividends (it is not a must). So if it is not a must, then why do companies do it?
- Issuing dividends keeps shareholders happy and satisfied.
- It makes it more appealing for investors to buy your shares.
Stock Index: An index takes a bunch of share prices and fuses them into one convenient number. Let’s look at the U.S for example. There are 2 main stock exchanges, the NYSE (New York Stock Exchange)and Nasdaq. Different companies are listed on these stock exchanges (see note 2 ). So what happens if you want to know how the stock market is doing in general in the United States? Then you need to take into consideration both the NYSE and Nasdaq. This is where Indexes come in handy. You can look at the S&P 500 index which measures the performance of 500 large company’s share prices in the United States. In South Africa, you get mainly the JSE All Share Index (ALSI).
Blue Chip Stock: These are referring to the shares of companies that have built a reputation for themselves and which tend to be large. This companies are reliable as they have built a good track record for themselves and they have strong financials. An example can be Nike or Apple, which are relatively stable companies. The logic is that when you buy blue-chip stocks you should be acquiring less risk than if you invest in a smaller less established company, as it is hard for other companies to take market share from well established companies. These companies should have a long track record of issuing dividends (blue-chip companies). The pro is that it is very unlikely that you will make any considerable losses when investing in these companies. The con is that the shares tend to be stable, therefore chances are you won’t make crazy high profits. You can although make a considerable profit if you invest in these companies over the long-term, but I do not recommend investing in these companies if you are looking to make money fast. You make high profits when you invest in risky companies whose value shoots up as they grow. The rule of thumb is the greater the risk the higher the return.
VC (Venture Capital): This is capital provided by venture capitalists or Venture Capital Firms. These firms provide the capital needed in order for a startup business to grow. They do this in exchange for a percentage of ownership in the company.
So let’s say before Joja Retailers went public I needed money to buy more sneakers, I could have approached a VC firm and pitched my business idea. They would give me the capital I needed in exchange for a percentage of ownership in my company (e.g 30%).
Angel Investor: An angel investor is similar to a Venture Capitalist except that they use their own money to invest in a startup business. A good example of this is the show ‘Dragons Den’ when entrepreneurs pitch their business ideas to potential angel investors called ‘Dragons.’
Stop-loss order: Remember Marylin, the shareholder in Joja Retailers who owns 150 shares, well let’s say it is December and she wants to go on holiday. She won’t be able to keep an eye on how the Joja Retailers share price is doing and doesn’t want to come back to find out that she has made a huge loss. So she can implement a stop-loss order to ensure that if the share price drops below e.g R5 a share, then all her shares must be sold. This acts as a safety net and reduces her possible losses if the company shares start to suddenly decrease in value while she is away on holiday. She can now enjoy her holiday with no stress! Similarly, an order can be put in to sell all of Marylin’s shares once the share price goes above a certain limit. Let’s say Marylin wants to ensure that if Joja Retailers’ share price goes above R8 all her shares must be sold. She bought the shares at R6 a piece. She is only looking to make R2 profit per share, then this is when a stop-loss order comes in handy.
Long-term investors won’t use this as much as they are looking to make money over a long period of time and don’t focus as much on the day-to-day fluctuations of the business.
Now this might be a bit too much for you to handle. You can approach a brokerage firm that will invest in companies for you, but they will charge you a fee of course. Unfortunately, you need to be at least 18 to begin trading stocks. If you are really eager to trade and you are below 18 then you can just ask an adult, like one of your parents, to trade on your behalf.
Just know that trading is a risky business, it isn’t for the faint-hearted but at the same time, you can make considerable money trading stocks. Of course, there is way more to trading than I have mentioned, but this gives you the just of things. So next time you hear them talking about the stock market on the radio, you can share your newly found knowledge with whoever is listening with you! and maybe teach them a thing or two ;)
Note 1 | I say this because it can be really hard to calculate a person’s actual net worth because wealthy people tend to have many investments which they do not disclose publicly. If a person’s wealth is mostly tied up in public companies, then their net worth is relatively easy to calculate. On the contrary, if a person’s wealth is mostly in privately held assets like real estate, then that requires investigation and is more difficult to calculate. In both cases, a certain level of estimation, educated guesses, and tallying up information from publicly available resources is required.
Note 2 | IBM and mature companies are listed on the NYSE while relatively new and mostly technology companies are listed on Nasdaq, like Apple.
