Stock Market Explained for Beginner Investors
Does this look scary to you? This used to be a scene from a typical trading day—- stock exchange. And this is what comes to the mind of most of us when we think of the stock market. Yes, I know that all this can be a bit overwhelming and scary for a beginner investor. But It need not have to remain that way; fear comes from lack of knowledge. So let's improve our understanding by answering three basic questions concerning every trade. And I am going to do it in the most beginner-friendly way. So let's get started.
If you are new to the blog, my name is Srijith, and here we talk everything about wealth, happiness, and sometimes credit cards. Before I answer those three critical questions, let's go back in time. That's too much. No. They didn't trade for sure. Let's fast forward a bit. Yea, Around there, the late 1400s. This is Antwerp or modern-day Belgium and it was the center of international trade then. The Venetians brought precious gems from the Far East, while the Germans shipped in furs and rye.
But they were individual merchants, and there weren't any companies existing yet. So the merchants who visited the city for trade stayed in local inns, and the innkeepers started helping them to exchange their goods and sell their wares.
One of the most important innkeeping families was called Van der Buerse. Their role in brokering these early economic trades led to the formation of the word "beurs," or "bourse" in French and German, meaning stock market. By the early 16th century, merchants were trading less often in real goods and more in notes which contained promises from one person to lend money to another. This turned out to be a very successful formula, and it started spreading to other countries.
Now let's fast forward a bit to the 17th century. This was the early stages of imperialism. Britain, France, and the Netherlands were all chartering voyages to the East Indies. These voyages required a lot of money, to buy ships, food, and arms and very few explorers could afford them. And then there was the risk factor. The earliest voyages were highly unsuccessful due to pirate attacks, bad weather, and poor navigation. Many ships were lost, and the financier's fortunes were seized by creditors.
Put simply, sailing to the far corners of the planet was too risky and expensive for any single company. This led a group of merchants to come together and jointly finance all the voyages.
So they can raise enough capital and also reduce the individual risk. Instead of investing in one journey, investors could spend money on multiple companies and limit their liabilities. That's how LLCs or limited liability companies came into existence. These early companies often lasted for only a single voyage. They were then dissolved, and for the next journey, a new one was created.
Things changed in 1600 when Queen Elizabeth I issued a charter with exclusive trading rights to the Company named the 'Governor and Company of Merchants of London trading into the East Indies'. This was the famous East India Company. People could invest money in the Company, and each investor was entitled to a fixed percentage of the Company's profits. The investment records were issued on paper, which they could sell to other investors. But without having a centralized place to sell and buy these investment documents, they had to track down a broker every time they had to carry out a trade.
So these traders decided to meet in the London coffee house and use it as a marketplace. Eventually, the coffee house stopped serving coffee and changed its name to the London Stock Exchange. And those investment documents on paper were the first stocks.
Today, virtually every country in the world has its own stock market. The stock market investment would continue to be the most popular investment option because of the high returns in the long term. You cannot simply avoid this if you want to make a considerable profit and let the money work for you. Having said that let's answer the 3 essential questions.
What to trade?
What we essentially buy are stocks or shares and those are stakes in a company. By being a shareholder of a company, you own a slice of the company. But why do modern companies issue shares in the first place? Let's see a typical path a newly founded business takes, with a simple story. So there was this guy, let's call him Steve, who had a brilliant business Idea. So he teamed up with one of his best friends and decided to start a company to turn his idea into a product.
But like everyone else, he was hit by the common beginner problem – where to find money? And like everyone else, he digs into his savings. And with that money, he managed to somehow get his business off the ground. Steve rents out a small building in the basement of his house and starts his small production unit. The products were well received by people, and demand started to increase slowly. That meant the Company had to move out of the basement into a bigger production unit. But Steve didn't have enough funds. So he started searching for rich investors to invest in his Company.
Luckily he found someone who agreed to invest in the company in return for 1/3rd of the ownership. These individuals who provide financial backing for small startups or entrepreneurs are called angel investors.
So with this extra money, Steve could build a production factory and spend more on marketing and design. The products got better, and the demand kept increasing. And now Steve wanted to grow his business further and expand to other countries. That meant more money was required, and this was much greater than what a single angel investor could provide. So Steve decides to get money from a large group of people or the common public. So Steve split the company's ownership into many small units and sold them for a base price. The base price of a unit was based on the general perception of the company, market demand, and supply.
This step is called the initial public offering or IPO. Anyone who buys 1 unit of Steves's company will have 1/nth ownership in the company. By doing so, Steve could also reduce his risk and spread it amongst many people. Now the status of the Company is officially changed from a private-owned enterprise to a publically traded company. The Company raises enough capital expands its operations, and becomes a huge success. Steve is Steve Jobs, the Company is Apple, and one unit of the Company is called stock or a share.
By owning stocks of Apple, you technically own a part of the company, and you get a say in the company matters. But it doesn't make sense to own these shares if you don't have any way to sell them. And that brings us to the next question, Where?
Where to trade?
Just like you don't go to a toothpaste factory to buy toothpaste, you don't knock at the door of Apple asking for stocks. The trade happens at exchanges where existing owners of shares can transact with potential buyers. I explained about the early stock market and how it came into existence. The concept is still the same, just that all the paperwork paved the way for digital transactions. You can't just show up and pick your shares off a shelf the way you select products in your local market. As an investor, you are typically represented by brokers, who make the necessary trade on your behalf. Common examples of German Stock Brokers are Scalable Capital and Trade Republic.
In Germany, most of the trade happens at the Frankfurt Stock Exchange. Similarly, In the US, most of the trade happens through the New York Stock Exchange. Trading hours are fixed and normally start around 9 to 10 in the morning and go until 4 to 5. The markets are closed over the weekends. But what exactly do they do in the stock market? Can you just turn up at the doors of the Frankfurt Stock Exchange and buy some stocks? This brings us to the next question How?
How to trade?
The most common way the trade happens in a stock exchange is through an auction. Buyers and sellers place bids and offer to buy or sell. A bid is a price at which somebody wishes to buy, and an offer (or ask) is the price at which somebody wishes to sell. When the bid matches the offer, a trade is made. I am not going into a detailed explanation of how the prices are set, but know it's the role of the stock exchange to coordinate and adjust the bid and ask prices. So when you buy a stock on the exchange, you are not buying it directly from the company. Instead, you are buying it from someone who already holds it and wants to sell it.
Let's go back to Apple. You are a beginner investor who believes in the Company's prospects and would like to invest. Since you can trade only through a broker, you log in to your trading account provided by your stockbroker and place an order for 10 shares at the current market price of 100$. Once your order hits the market, the stock exchange (through their order matching algorithm) tries to find a seller who is willing to sell you these 10 shares of Apple at 100$ each.
The seller could be 1 person willing to sell the entire 10 shares, or it could be 10 people selling 1 share each, or 2 people selling 1 and 9 shares, respectively. It doesn't matter. The stock exchange ensures the shares are available to you as long as there are sellers in the market. Once the trade is executed, the shares will be electronically credited to your account. Likewise, the shares will be electronically debited from the seller's account. And that's how the stock market works. But how do you make money out of shares?
As the Company starts to grow and make profits, so does the value of its stock. Suppose the price of one share of Apple reaches 150$ in a year, the value of the 10 stocks you have becomes 1500$. And you make a 500$ profit if you sell them. This is how you make money in the stock market by selling a stock at a higher price than what you purchased. The catch here is no one can guarantee that the Company's value will increase over time. It could just as easily go down, thereby reducing the value of the stock you own and your investment.
If the thought of investing in the stock market scares you, you are not alone. But by improving your understanding you can do better as an investor. Is buying and selling stocks the only way to make money in the stock market? Nope. There are also other options for you as a beginner investor. That's why you have to watch this where I talk about other trading possibilities. If you liked my blog, do visit my blog again and share it with whoever may need it.
Disclaimer: The Content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. It is important to do your own analysis before making any investment.
