What is the difference between the stock market,common stock and other instruments?
The stock market is the third largest financial market after the currency and bond markets. Its volume is over $60 trillion dollars and it fluctuates along with global stock market prices. A major difference between common stock and other instruments is for example, a futures contract, has a time limit (usually 3-12 months) and bonds mature while common stocks can be accumulated and sold at all times, until the company ceases to exist.
How does the stock market work?
A common stock represents a share in a company granting certain rights to its buyer, for example, the right to vote for the Board of Directors, to receive dividends, etc. Stock may be traded on the stock market or OTC. On the stock market, for example, the MICEX or NYSE, trading is regulated by stock exchange protocols. To be able to purchase stock on the stock exchange, a company must follow a set of procedures, disclose information to investors, meet exchange requirements regarding its sales volume, earnings, number of shareholders, etc. The stock market is a liquid market, meaning you can easily buy or sell shares of a company trading on the exchange. Individual investors usually buy stock through brokers which are licensed companies eligible to sell and buy stock. The Over the Counter (OTC) market includes all stock transactions executed outside the stock exchange. This exchange contains a market less liquid.
What are the long-term dynamics of the stock market?
The global stock market average capitalization growth was 8.1% between 1990 and 2009; it was 11.8% between 2009 and 2010. These numbers include not only return on equity, but the appearance of new public companies as well. For example, in the US, the market rate of return has been, on average, a bit over 10% during the last 30 years. But since 2000, during the so-called “lost decade”, those who invested in technology companies in 2000 earned nothing. When investing, one should clearly understand when to enter the market and which company to purchase, “buy a good company for a good price”, as they say.
Where are the most developed markets?
The development of a stock market is directly connected to the level of economic development within the country. There is an index indicating the ratio between the country’s market capitalization and the volume of its economy (GDP). In the US, this index is over 100%, while emerging countries may have an index of 40-80%. China presents the most illustrative example, actively developing the domestic stock market. The basis for stock market stability is the investment horizons of its participants. The longer the investment horizon the more stable the stock market. One of the bases for “long-term money” in a country is the pension fund reserve. Russia, for instance, has much work to do in this area.
How can people earn income on the stock market?
There are two ways: receive dividends and/or capital gains. Historically, investors gained over half of the returns on investments in stock due to market value growth.
What should an investor know prior to purchasing stock?
Firstly, people coming to the stock market believing that they will be earning 100% annual income in the long run are mistaken. Such percentages are absolute exceptions to the rules and there are less than 2% of such investors on the market. Naturally, every one considers themselves a genius which isn’t such a bad thing. While investing in stock one should consider not only how much they want to earn but also what risks to take into consideration. A real risk-free return is the return on an insured bank deposit. If you want a 100% annual return, you should understand that the risks are at least 10 times greater than the risks associated with an insured bank deposit. We remember that 1990’s and know that even deposits at most safest banks could be lost.
A serious approach to choosing stocks requires serious and diligent work analyzing regional and global markets, industries and companies. In general, in developed markets, about a third of the stock price movement is defined by the country’s stock market as a whole. Another third is defined by a company’s and the other third depends on news and indexes of the company itself, such as expectations and earnings. Therefore, making a long-term investment decision and analyzing correctly only the company, for example, by its balance sheet, profit and loss reports, will only allow 1/3 of a correct market decision. This fraction may be even smaller in developing countries. For instance, while investing in Russian companies, foreign investors must first consider the general state of the country. As an example, we can currently observe situations influencing the market in Argentina.
Everyone has their own way of analyzing the markets. A mathematician can create data sets, identifying probabilistic laws. An individual with a technical education may be familiar with a company’s product, its technology, and thus analyze it to predict how the company will evolve in the future. A day-trader may analyze the emotions of market participants through graphs. High trading volume may be a sign of high emotions; and fear or greed may be shown depending on the level trading as well. An economist may analyze macro characteristics, industry development, and fundamental indexes of a company to make a decision.
In conclusion, there is one obvious thing: don’t put all of your eggs into one basket. This means that a portfolio should include 17-25 companies from different industries to eliminate most non-systematic risks. If any less, there is insufficient diversification in the portfolio; if any more, the upkeep of the portfolio becomes too time-consuming.
Disclaimer: This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service. Performance data shown represents past performance. Past performance is no guarantee of future results. No part of this article may be copied, distributed, transmitted or published without the prior written consent of the author.
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