Stocks/Shares
Definition
In business and finance, a share (also referred to as equity share) of stock means a share of ownership in a corporation (company).
When you buy stock in a corporation, you become one of its owners. If the company does well, you may receive part of its profits as dividends and see the price of your stock increase. But if the stock price falls, the value of your investment can drop, sometimes substantially.
A stock has no absolute value. At any given time, its value depends on whether its shareholders want to hold it or sell it, and on what other investors are willing to pay for it. If the stock is hot, and lots of people want shares, the price may go up. If a company is losing money or a particular industry is doing poorly, those stocks may drop in value. Some stocks are undervalued, which means they sell for less than analysts think they're worth, while others may be overvalued.
Investors' attitudes are determined by several factors: whether or not they expect to make money with the stock, by current stock market conditions, and the overall state of the economy.
Types of Stock
Stock typically takes the form of shares of either common stock or preferred stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions. Preferred stock differs from common stock in that it typically does not carry voting rights but is legally entitled to receive a certain level of dividend payments before any dividends can be issued to other shareholders.
Buying Stocks
Though you probably use the term broker to describe all the professionals who buy and sell stocks, the financial markets use titles to describe more precisely the ways securities change hands.
Brokers handle buy and sell orders placed by individual and institutional clients. They may earn a commission on each transaction or receive an annual fee based on the value of the client's account.
Dealers buy and sell securities for their own or their firm's account, helping to keep the market liquid. Dealers make their money on the difference between what they pay to buy a security and the price they can get for selling it.
Traders, also called registered or competitive traders, buy and sell securities for their own portfolios. The term trader also describes those employees of broker-dealers who handle the firms' securities trading.
Usually you buy or sell stock in multiples of 100 shares, called a round lot. But in some countries (e.g. United States) you can buy just a single share, or any number you can afford. That's called an odd lot. Brokers at one time charged you more to buy and sell odd lot orders. But now these orders are handled electronically, without additional charge.
Value movement
“A stock's value can change at any moment, depending on market conditions, investor perceptions, or a host of other issues.”
The price of a stock fluctuates fundamentally due to the theory of supply and demand. A stock doesn't have a fixed price, or value. When investors are buying the stock, the price tends to go up. But if they think the company's outlook is poor, or if the overall market is weak, they either don't invest or sell shares they already own. Then the price of the stock tends to fall.
But price is only one way to measure a stock's value. Return on investment — the amount you earn by owning the stock — is another. To assess return, you add any increase or decrease in price from the time of purchase and any dividends the stock has paid over that time. Then you divide by the amount you invested to find percent return. As a final step, you can find the annualized return by dividing the return by the number of years you owned the stock.
The stock market goes through cycles, heading up for a time, and then correcting itself by reversing and heading down. A rising period is known as a bull market — bulls being the market optimists who drive prices up. A bear market is a falling market, where stock prices fall by 20% or more and may remain depressed. Overall, the market has tended to rise higher following a fall. But bear markets can take a big bite out of your portfolio's value in the short term.
Derivatives
Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, or other derivatives). Credit derivatives are based on loans, bonds or other forms of credit.
The most common type of derivatives being used are: futures and options.
Options
An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, such as a piece of property, or shares of stock or some other underlying security, such as, among others, a futures contract. In return for granting the option, the seller collects a payment (premium) from the buyer.
Call Option
In the case of an equity option, a contract that gives the buyer the right, but not the obligation, to purchase a set amount of stock (usually 100 shares) at a predetermined price anytime before the contract expires (American Style option) or at expiration only (European Style Option). The predetermined price is known as the strike price.
Put Option
In the case of an equity option, a contract that gives the holder the right, but not the obligation, to sell a stock at a set price for limited period of time. The seller or writer of the option is obligated to buy the stock at the strike price in the event that the option is assigned.
| Holder (Buyer) | Writer (Seller) |
Call Option | Right to buy | Obligation to sell |
Put Option | Right to sell | Obligation to buy |
Futures
What are Futures?
A futures contract is the obligation to receive or deliver a commodity or financial instrument at a specific date in the future at an agreed upon price today.
These contracts have the following standard specifications:
1. Underlying instrument
The commodity, financial instrument, or index upon which the item is based.
2. Size
The amount of the underlying item covered by the contract.
3. Delivery or contract cycle
The specified months for which contracts can be traded.
4. Maturity date
The date by which all particular futures trading month ceases to exist and all obligations must be fulfilled.
5. Grade/quality specification and delivery locations
A detailed description of the commodity or security and where, when, and how it can be delivered.
6. Settlement procedures
Rules for physical delivery of the underlying item, including how payments are made and received, or the specific cash series and procedures used for cash settlement of the contract.
These contracts are traded on an organized and regulated futures exchange enabling buyers and sellers to transact business. In most cases, traders fulfill the obligation of the contract by taking the offsetting position. For example, if a trader is long a futures contract, he must sell the contract prior to the expiration date to avoid taking delivery of the physical commodity.
Futures and Options Distinctions
While both futures and options are derivative products, they have their differences in terms of obligations.
| Options | Futures |
Buyer | Has the right to buy or sell the underlying security | Has the obligation to take delivery of the underlying commodity or financial instrument on expiration at the settlement price. |
Seller | Has the obligation to buy or sell the underlying security | Has the obligation to make delivery of the underlying commodity or financial instrument on expiration at the settlement price. |
Traders that hold futures position always have the obligation to buy or sell the underlying commodity. In order to meet this obligation, traders need to offset the futures position.
In most equity markets, 1 Options Contract gives the right to buy and sell 100 shares while 1 Future Contract normally involves 1000 shares. Thus, options are more affordable to most people as compared to futures.
Leveraged Trading
Stock that a trader does not actually own may be traded using short selling; margin buying may be used to purchase stock with borrowed funds; or, derivatives may be used to control large blocks of stocks for a much smaller amount of money than would be required by outright purchase or sale. Be cautious that this type of trading involves higher risk and may result in the loss of the initial amount. Not advised for amateur traders.
Short selling
In short selling, the trader borrows stock (usually from his brokerage which holds its clients' shares or its own shares on account to lend to short sellers) then sells it on the market, hoping for the price to fall. The trader eventually buys back the stock, making money if the price fell in the meantime or losing money if it rose. Exiting a short position by buying back the stock is called "covering a short position." This strategy may also be used by unscrupulous traders to artificially lower the price of a stock. Hence most markets either prevent short selling or place restrictions on when and how a short sale can occur. The practice of naked shorting is illegal in most (but not all) stock markets.
Margin buying
In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value.
Contract for Difference (CFD)
Another example of leveraged trading is CFD. A contract for difference (or CFD) is a contract between two parties, typically described as "buyer" and "seller", stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. (If the difference is negative, then the buyer pays instead to the seller.) For example, when applied to equities, such a contract is an equity derivative that allows investors to speculate on share price movements, without the need for ownership of the underlying shares
Contracts for difference allow investors to take long or short positions, and unlike futures contracts has no fixed expiry date, standardized contract or contract size. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 30% of the notional value for CFDs on leading equities.
Currency or Forex Trading
Is another form of trading which capitalize on the the movement of the exchange rate between basecurrency and quote currency (often mentioned as currency pair). The aim is to earn the difference by converting between the 2 currencies at different timing. Often the currency pair being used are US Dollar (USD) and the local currency, depending on the location of the trader. Another way is to trade using major currency pair. The Majors are: EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD and USD/CAD.
There are also a few derivatives used in forex trading, but I won't go in depth on the subject.
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"The only way to have plenty of money is to learn how to handle the money"
