Brokerage and taxation

Investors beware of: Brokerage and taxation!

You probably know the concept that all your transactions in the stock market are done though a "stockbroker". A stockbroker earns a commission on whatever transaction you make. Suppose you make a transaction of Rs.2000, and the stockbroker charges you a 3% commission, then you have to pay the stockbroker Rs.60 (3% of Rs.2000) for the transaction. So your total investment in the transaction in “not Rs.2000”. The total investment in the transaction is Rs.2060/-

So after sometime, if the price of the stocks you invested in goes up to Rs.2060 then you have not made any money because the total amount you invested was Rs.2060/-

What is more, even when you sell the stocks, you have to pay the broker brokerage of 3%. This means that, when you sell the stocks for Rs.2060, you have to pay the broker Rs.61.6 so the profit of Rs.60 you made on the transaction is gone, in fact you actually make a loss of Rs.1.6!!

So in effect even though you made a profit of Rs.60 because your stock price went up, you have actually made a loss.

If combine this with the fact that inflation reduces the value of money over time, you are just loosing money if you do not invest wisely without understanding brokerage and inflation.

Important note about brokerage: Brokers make money on whatever transaction you make. Whether you buy or sell, brokers will make money. Because brokers basically make money on transactions. Because of this, brokers tend to encourage you to trade. They don’t really care about whether you make a profit or loss. They just care about whether you are trading. The more money you are using for trading, the more they will make. Because of this, it would be wise to not blindly follow your brokers advise. The broker will give you “hot tips” etc. not because they are looking out for you and your profit, but because they are thinking about their own personal profit!

There is even one more factor that eats into your money. Tax!!!

Please note: We are not in any way encouraging you to not pay tax! We are just educating you about it.

There is a “short term capital gain tax” in our country. For a short term (less than one year) you have to pay tax on any capital gain you make though the stock market trading. How much % tax you have to pay, depends on which "tax bracket" you fall in.

Just to give you an idea. If I make Rs.100 though a transaction in the stock market, since I fall in the 33% tax bracket. It have to pay Rs.33 of that to the government!!

Please note: The government encourages you to be a long term-investor by having no long term capital gain tax. If you make a capital gain by investing for a period greater than one year, the you do not have to pay any tax on the money you make.

Now combine this short term capital gain tax with brokerage and inflation! Think about it for some time. You will almost make nothing on a small profit gains! If you want to make money out of the stock market, you must make large profit gains.

Conclusion: As a general rule, just for the sake of simplicity, your investments must grow at a minimum rate of 15% per year to stay ahead of inflation, tax and brokerage!! Remember this when making all your investments.

This concludes our basics of the stock market guide. There is lot more to learn! And the best way to do it is to start investing! (Don’t invest too much in the beginning but do start!) Once you have your money in the market, you will start to understand things a whole lot better!

Inflation

"Inflation" & how it eats your money silently & affects your investments!

Inflation, is an economic concept. What the cause of inflation is, is not important to us from the point of view of this article. What is important to us is the effect of inflation! The effect of inflation is the prices of everything going up over the years.

A movie ticket was for a few paise in my dad’s time. Now it is worth Rs.50. My dads first salary for the month was Rs.400 and over he years it has now become Rs.75,000. This is what inflation is, the price of everything goes up. Because the price goes up, the salaries go up.

If you really thing about it, inflation makes the worth of money reduce. What you could buy in my dad’s time for Rs.10, now a days you will not be able to buy for Rs.400 also. The worth of money has reduced! If this is still not clear consider this, when my father was a kid, he used to get 50paise pocket money. He used to use this money to go and watch a movie (At that time you could watch a movie for 50paise!)

Now, just for the sake of understanding assume that my dad decided in his childhood to save 50paise thinking, that one day when he becomes big, he will go for a movie. Many years pass. The year now is 2006. My dad goes to the theater and asks for a ticket. He offers the ticket-booth-guy at the theater 50paise and asks for a ticket. The ticket booth guy says, “I am sorry sir, the ticket is worth Rs.50. You will not be able to even buy a “paan” with the 50paise!!”

The moral of the story is that, the worth of the 50paise reduced dramatically. 50paise could buy a whole lot when my dad was a kid. Now, 50paise can buy nothing. This is inflation. This tells us two important things.

Firstly: Do not keep your money stagnant. If you just save money by putting it your safe it will loose value over time. If you have Rs.1000 in your safe today and you keep it there for 10years or so, it will be worth a lot less after 10 years. If you can buy something for Rs.1000 today, you will probably require Rs.1500 to buy it 10 years from now. So do not keep money locked up in your safe.

Always invest money.

If you can’t think where to invest your money, then put it in a bank. Let it grow by gaining interest. But whatever you do, do not just lock your money up in your safe and keep it stagnant. If you do this, you will be loosing money without even knowing it. The more money you keep stagnant the more money you will be loosing.

Secondly: When investing, you have to make sure that the rate of return on your investment is higher than the rate of inflation.

What is the rate of inflation?

As we said earlier, the prices of everything goes up over time and this phenomenon is called inflation. The question is: By how much do the prices go up? At what rate do the prices do up?

The rate at which the prices of everything go up is called the "rate of inflation". For example, if the price of something is Rs.100 this year and next year the price becomes approximately Rs.104 then the rate of inflation is 4%. If the price of something is Rs.80 then after a year with a rate of inflation of 4% the price go up to (80 x 1.04) = 83.2

So, when you make an investment, make sure that your rate of return on the investment is higher than the rate of inflation in your country. In our county India, for the year 2005-2006 the rate of inflation was 4% (Which is really low and amazing!). This rate keeps changing every year. The finance minister generally gives the official statement on the inflation rate of the country for a particular year

What is the rate of return?

The rate of return is how much you make on an investment. Suppose you invest Rs.100 in the market and over a year, you make Rs.120, then you rate of return is 20%.

If you invest Rs.100 in the market today and you make money at a 3% "rate of return" in one year you will have Rs.103. But now, since the rate of inflation is at 4%, an item costing Rs.100 today will cost Rs.104 a year from now. So what you can buy with today’s Rs.100, you will only be able to buy with Rs.104 a year from now.

But the Rs.100 that you invested has grown only at a 3% rate of return and so it is worth Rs.103. In effect, you are loosing money!

So in conclusion, the rate of return on your investments, have to be higher than the rate of inflation.

From the above paragraphs you can note how silently, inflation eats into your money. You would not even know about it an your money would sit loosing value for no fault of yours. But inflation is not the only thing you should be considering, there are other things too that eat into you money. The first thing is “brokerage” and the second thing is “taxation”.

Price to future growth ratio!

PEG (Price to future growth ratio!) and what it tells you!

The market is usually more concerned about the future than the present, it is always looking for some way to figure out what is going to happen in the companies future.

A ratio that will help you look at future earnings growth is called the PEG ratio.

You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.

PEG = (P/E) / (projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 30 / 15 = 2.

What does the “2” mean?

Technically speaking: The lower the PEG number, the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.

So, to put it very simply, we are interested in stocks with a low PEG value.

Just for the sake of understanding, consider this situation, you have a stock with a low P/E. Since the stock is has a low P/E, you start do wonder why the stock has a low P/E. Is it that the stock market does not like the stock? Or is it that the stock market has overlooked a stock that is actually fundamentally very strong and of good value?

To figure this out, you look at the PEG ratio. Now, if the PEG ratio is big (or close to the P/E ratio), you can understand that this is probably because the “projected growth earnings” are low. This is the kind of stock that the stock market thinks is of not much value.

On the other hand, if the PEG ratio is small (or very small as compared to the P/E ratio, then you know that it is a valuable stock) you know that the projected earnings must be high. You know that this is the kind of fundamentally strong stock that the market has overlooked for some reason.

Important note: You must understand that the PEG ratio relies on the projected % earnings. These earnings are not always accurate and so the PEG ratio is not always accurate.

Having understood these basic three ratios, you probably have started to understand how these ratios help you understand a stock and what is valuable and what is not.

In the next section we shall look at some of the things that every investor must know about. Something that SILENTLY eats into the profits of each and every investor and how to beat it...

Price to earning (P/E) ratio

Price to earning (P/E) ratio & what it means?

If there is one number that people look at than more any other number, it is the “Price to Earning Ratio (P/E)”. The P/E is a ratio that investors throw around with confidence as if it told the complete story. Of course, it doesn’t tell the whole story (if it did, we wouldn’t need all the other numbers.)

The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is the most popular stock analysis ratio, although it is not the only one you should consider.

You calculate the P/E by taking the share price and dividing it by the company’s EPS (Earnings Per Share that we saw above)

P/E = Stock Price / EPS

For example: A company with a share price of Rs.40 and an EPS of 8 would have a P/E of: (40 / 8) = 5

What does P/E tell you?

Some investors read a high P/E as an “overpriced stock”.

However, it can also indicate the market has high hopes for this stock’s future and has bid up the price.

Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean that the market has just overlooked the stock. Many investors made their fortunes spotting these overlooked but fundamentally strong stocks before the rest of the market discovered their true worth.

In conclusion, the P/E tells you what the market thinks of a stock. It tells you whether the market likes or dislikes the stock. If things are vague and unclear to you, do not worry. The next ratio will make everything you read till now make sense..

Earnings per share (EPS) ratio & what it means!

Even comparing the earnings of one company to another really doesn’t make any sense, if you think about it. Earnings will tell you nothing about how many shares the company has. Because you do not know how many shares a company has, you do not know how many parts that companies earnings have to be divided into. If the company has more shares, the earnings will be divided into more parts.

For example, companies A and B both earn Rs.100, but company A has 10 shares outstanding, so each share holder has in effect earned Rs.10.

On the other hand, if company B has 50 shares outstanding and they too have earned Rs.100 then each shareholder has earned Rs.2. So you see it is important to know what is the total number of outstanding shares are as well as the earnings.

Thus it makes more sense to look at earnings per share (EPS), as a comparison tool. You calculate earnings per share by taking the net earnings and divide by the outstanding shares.

EPS = Net Earnings / Outstanding Shares

So looking at the EPS ratio, you should go buy Company A with an EPS of 10, right? EPS is not the only basis of comparing two companies, but it is one of the methods used.

Note that there are three types of EPS numbers:

• Trailing EPS – last year’s numbers and the only actual EPS
• Current EPS – this year’s numbers, which are still projections
• Forward EPS – future numbers, which are obviously projections

EPS doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some other ratios next....

The Basics of Fundamental Analysis

Fundamental Analysis Definition

Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices.

The fundamental information that is analyzed can include a company's financial reports, and non-financial information such as estimates of the growth of demand for products sold by the company, industry comparisons, and economy-wide changes, changes in government policies etc..

General Strategy

To a fundamentalist, the market price of a stock tends to move towards it's “real value” or “intrinsic value”. If the “intrinsic/real value” of a stock is above the current market price, the investor would purchase the stock because he knows that the stock price would rise and move towards its “intrinsic or real value”

If the intrinsic value of a stock was below the market price, the investor would sell the stock because he knows that the stock price is going to fall and come closer to its intrinsic value.

All this seems simple. Now the next obvious question is how do you find out what the intrinsic value of a company is? Once you know this, you will be able to compare this price to the market price of the company and decide whether you want to buy it (or sell it if you already own that stock).

To start finding out the intrinsic value, the fundamentalist analyzer makes an examination of the current and future overall health of the economy as a whole.

After you analyzed the overall economy, you have to analyze firm you are interested in. You should analyze factors that give the firm a competitive advantage in it’s sector such as management experience, history of performance, growth potential, low cost producer, brand name etc. Find out as much as possible about the company and their products.

Do they have any “core competency” or “fundamental strength” that puts them ahead of all the other competing firms?

What advantage do they have over their competing firms?

Do they have a strong market presence and market share?

Or do they constantly have to employ a large part of their profits and resources in marketing and finding new customers and fighting for market share?

After you understand the company & what they do, how they relate to the market and their customers, you will be in a much better position to decide whether the price of the companies stock is going to go up or down.

Having understood the basics of fundamental analysis, let us go into some more details.

When investing in the stocks, we want the price of our stock to rise. Not only do we want our stock price to rise, we want it to rise FAST! So the challenge is to figure out: which stock prices are going to rise fast?

Some stocks are cheap and some are costly. Some are worth Rs.500 and some are even worth 50paise. But the price of the stock is not important. The price of the stock does not make a stock good to buy. What is important is how much the price of the stock is likely to rise.

If you invest Rs.500 in one stock of Rs.500 and the price goes up to Rs.540 you will make Rs.40. However, if you invest Rs.500 in a 50paise stock, you will have 1000 stocks. If the price of the stock goes up from 50paise to Rs.1, then the Rs.500 you invested is now Rs.1000. You made a profit of Rs.500.

If you understand this, you can see that the price of the stock is not important. What is important is the rise in the stock’s price. More specifically the “percentage” rise in the stock price is important.

If the Rs.500 stock becomes worth Rs.540, then that is a 8% rise. This 8% rise only makes us Rs.40. On the other hand when we invest the same Rs.500 in the 50paise stock and the stock price goes up to Rs.1, it is a 100% rise as the stock price has doubled. This 100% rise makes us Rs.500.

The point is that when picking a company, we are interested in a company whose stock price will rise by a large percentage.

Please note: Looking at the above paragraphs, it may seem like a good idea to buy all the really cheap 50paise and Rs.1 stocks hoping that their price will rise by 100% or more. This sounds good, but it can also be really really bad some times! These really small stocks are very volatile and unless you know what you are doing, do NOT get into them.

However, the point to be noted is that we are interested in stocks that will have the highest % rise in the stock price. Now the question is, how do you compare stocks. How do you compare a stock worth Rs.500 to a stock worth 50paise and figure out which one will have a higher percentage rise.

How do you compare two companies that are in different fields and different industries? How do you know which one is fundamentally strong and which one is week?

If you try to compare two companies in different industries and different customers it is like comparing apples and elephants. There is no way to compare them!

So fundamental analysts use different tools and ratios to compare all sorts of companies no matter what business they are in or what they do!

Stock Picking

Stock Picking - Which stocks to buy?

Having understood all the basics of the stock market and the risk involved, now we will go into stock picking and how to pick the right stock. Before picking the right stock you need to do some analysis.

There are two major types of analysis:
1. Fundamental Analysis
2. Technical Analysis

Fundamental analysis is the analysis of a stock on the basis of core financial and economic analysis to predict the movement of stocks price.

On the other hand, technical analysis is the study of prices and volume, for forecasting of future stock price or financial price movements.

Simply put, fundamental analysis looks at the actual company and tries to figure out what the company price is going to be like in the future. On the other hand technical analysis look at the stocks chart, peoples buying behavior etc. to try and figure out what the stock price is going to be like in the future.

3 important things you must know and follow as an new investor!

You need to KNOW some “unforgettable basics” before you enter the world of investing in stocks. The stock market is a field dominated by savvy investors who know the ins-and-outs of the market. For people who are not “on the inside”, the stock market can be a VERY dangerous place. :

Don't even consider "tips" that tell you about "hot stocks". Consider the source:

There are many people in the market who put in all their time and effort in promoting certain stocks. They do this because they have their money invested in those stocks. If they can get enough people to buy the stock and they can get the stock price to rise, they will sell the stock for a huge price, the stock price will crash and they will walk off to promote another stock.

Always use your own brain:

It's extremely important. You must always use your own brain. Relying on the advice of others, no matter how well intentioned it may be, is almost always a complete disaster. Make sure you dig in and really examine the "facts about the companies" before you invest. Ignore press releases which have very little substance, and rely on "hype" to tell the company's story.

And finally the most important tip!!!
Only invest money you can afford to lose!! Sure this is a basic point, but many many people miss it. You should only invest money that you can honestly afford to lose!! Everyone enters into investments with the idea of earning big profits, but in many cases, this never works. (Especially if you are new to investing in the stock market!)

Please understand that the above tips are tips for beginners. Once you really get into the stock market you do not need to follow these rules anymore. But if you are a new investor, you MUST follow these rules. They are for your own safety.

But then again, nothing comes free. Everything has a price. You will have to loose some money, make some bad decisions and then only will you really understand the market. You cannot understand the market by just looking at it from far. By following these rules, you will basically not loose too much!

What is the Sensex & the Nifty?

The Sensex is an "index". What is an index? An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down.

The Sensex is an indicator of all the major companies of the BSE.

The Nifty is an indicator of all the major companies of the NSE.

If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down.

Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.

Just in case you are confused, the BSE, is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE.Most of the stock trading in the country is done though the BSE & the NSE.

Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of indexes.

There is an index for the metal stocks. There is an index for the FMCG stocks. There is an index for the automobile stocks etc.

But, before we go ahead and try to understand "How to make money in the stock market?" you MUST read the next page....

What makes stock prices change

What makes stock prices go "up" and "down"?

Stock prices change every day because of market forces. By this we mean that stock prices change because of “supply and demand”. If more people want to buy a stock (demand) than sell it (supply), then the price moves up!

Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. (Basics of economics!)

Understanding supply and demand is easy. What is difficult to understand is what makes people like a particular stock and dislike another stock. If you understand this, you will know what people are buying and what people are selling. If you know this you will know what prices go up and what prices go down!

To figure out the likes and dislikes of people, you have to figure out what news is positive for a company and what news is negative and how any news about a company will be interpreted by the people.

The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter).

Dalal Street watches with great attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection.

If a company's results are better than expected, the price jumps up. If a company's results disappoint and are worse than expected, then the price will fall.

Of course, it's not just earnings that can change the feeling people have about a stock. It would be a rather simple world if this were the case! During the “dotcom bubble”, for example, the stock price of dozens of internet companies rose without ever making even the smallest profit. As we all know, these high stock prices did not hold, and most internet companies saw their values shrink to a fraction of their highs. Still, this fact demonstrates that there are factors other than current earnings that influence stocks.

So, what are "all the factors" that affect the stocks price? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know is that stocks are volatile and can change in price very very rapidly.

Just remember this: At the most fundamental level, supply and demand in the market determines stock price.

There are many types of techniques and methods that investors use to figure out whether a stock price will go up or down! We will try to give you an introduction to these techniques in this article.

But before we go into the concepts of stocks picking, and the techiques of analysis, let us understand one last basic thing....

Why companies issue stocks ?

Why does a company issue stocks?

Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to "raise money". To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock.

A company can borrow by taking a loan from a bank or by issuing bonds. Both methods come under "debt financing". On the other hand, issuing stock is called “equity financing”. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way.

All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).

It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments.

This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn't guaranteed a return, neither is a shareholder. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.

It’s a tricky game!

Note that: There are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends. Without dividends, an investor can make money on a stock only through its appreciation of the stock price in the open market.

On the downside, any stock may go bankrupt, in which case your investment is worth nothing.

Having understood this, we now want to know what makes stock prices rise and fall? If we know this, we will know which stocks to buy. In the next section we will try to understand what makes stock prices go up and down.

Ownership of a company

So what does ownership of a company give you?

Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim to everything the company owns.

This means that technically you own a tiny little piece of all the furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well.

These earnings will be given to you. These earnings are called “dividends” and are given to the shareholders from time to time.

A stock is represented by a "stock certificate". This is a piece of paper that is proof of your ownership. However, now-a-days you could also have a “demat” account. This means that there will be no “stock certificates”. Everything will be done though the computer electronically. Selling and buying stocks can be done just by a few clicks.

Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, “one vote per share” to elect the board of directors of the company at annual meetings is all you can do. For instance, being a Microsoft shareholder doesn't mean you can call up Bill Gates and tell him how you think the company should be run.

The management of the company is supposed to increase the value of the firm for shareholders. If this doesn't happen, the shareholders can vote to have the management removed. In reality, individual investors like you and I don't own enough shares to have a material influence on the company. It's really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions.

For ordinary shareholders, not being able to manage the company isn't such a big deal. After all, the idea is that you don't want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets.

Profits are sometimes paid out in the form of dividends as mentioned earlier. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you'll receive what's left after all the creditors have been paid.

Another extremely important feature of stock is "limited liability", which means that, as an owner of a stock, you are "not personally liable" if the company is not able to pay its debts.

In other legal structures such as partnerships, if the partnership firm goes bankrupt the creditors can come after the partners “personally” and sell off their house, car, furniture, etc.

Owning stock means that, no matter what happens to the company, the maximum value you can lose is the value of your stocks. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.

Why would the founders share the profits with thousands of people when they could keep profits to themselves? This is the obvious question that comes up next. This what the next section is all about!

Stock Types

BLUE CHIP STOCKS

The stock market term "blue chip" comes from poker, where the blue chips carry the highest value. Large, established firms with a long record of profit growth, dividend payout and a reputation for quality management, products and services are referred to as Blue Chip companies. These firms are generally leaders in their industries and are considered likely candidates for long-term growth. Because Blue Chip companies are held in such high esteem, they often set the standards by which other types of companies in their fields are measured. Well-known blue chips include IBM, Coca-Cola, General Electric and McDonald's.

Blue chip stocks are included in the Dow Jones Industrial Average, an index comprised of 30 companies that are all major players in their respective industries. Popular among individual and institutional investors alike, the 30 stocks listed on the Dow account for about one fifth of the total market value (over $8 trillion) of all U.S. stocks. The types of Investors blue chip stocks attract are the ones who seek investments that pay moderate dividend yields and grow. These types of stock are usually priced high because of their demand, have relatively low volatility and deliver a steady stream of dividends. The main downside is that, since they are so large, they have little room to appreciate, compared to smaller, up-and-coming types of stock.

PENNY STOCKS

Penny stocks are low-priced, speculative stocks that are very risky. These stocks are generally issued by the type of companies with a short or erratic history of revenues and earnings. They are the lowest of the low in price and many stock market exchanges choose not trade them.

Penny stocks (also called designated securities) have these specific qualities: they sell for less than $5, they are sold over the counter (but not on the NASDAQ), and their companies have 2 million dollars or less in net tangible assets. They are listed daily on the Pink Sheets.

The appeal of penny stocks comes from their low price. Though the odds are against it, if the company that issued them suddenly finds itself on a growth track, their stock share price can rise rapidly. This type of stocks is popular among small speculators.

INCOME STOCKS

Income stocks are stocks that pay higher-than-average dividends over a sustained period. These above average dividends tend to be paid by large, established companies with stable earnings. Utilities and telephone company stocks are often classified as income stock types.

Income stocks are popular with types of persons investing for steady income for a long time and who do not need much growth in their stock's value (though some growth does occur). In this sense, investors who choose them have something in common with bondholders. Income stocks can actually be more profitable than bonds. To maximize income, some investors will even seek out companies that frequently raise their dividends and are not saddled with debt.

VALUE STOCKS

A value stock is a type of stock that is currently selling at a low price. Companies that have good earnings and growth potential but whose stock prices do not reflect this are considered value companies. Both the stock market and people investing in it are largely ignoring their stocks. Investors who buy value stocks believe that these stocks are only temporarily out of favor and will soon experience great growth. Any number of factors such as new management, a new product or operations that are more efficient may make a value stock grow quickly.

Many companies alternate between value and growth types of classification. It is a normal aspect of the business cycle. Investing in value stocks is attractive for those who watch markets carefully for undervalued stocks they feel will move upward.

OTHER TYPE OF STOCKS

Defensive stocks are those whose prices stay stable when the market declines and are issued by industries that naturally do well during recessions. Food and utilities companies are defensive stocks. Debt collection companies also tend to perform well when the market turns sour.

Cyclical stocks are a type of stocks that move up or down in sync with the business cycle. Examples include the housing industry and industrial equipment companies, because these companies serve the needs of growing economies. Investors who do not mind buying and selling as the market fluctuates tend to like cyclical stocks. Individuals who prefer to hold a stock for a long time may not like them unless they can weather ups and downs in the stock's value.

Gold stocks are the stocks of gold-mining companies. Their value moves up or down with the price of gold.

Treasury stock is a type of stock that has been bought back by the company that issued it. Companies may buy their stock back from investors when they believe it is underpriced on the market. The company can then set aside the stock for future uses such as debt payment or the awarding of stock options.

Crashes

A stock market crash is often defined as a sharp dip in share prices of equities listed on the stock exchanges. In parallel with various economic factors, a reason for stock market crashes is also due to panic. Often, stock market crashes end up with speculative economic bubbles.

There have been famous stock market crashes that have ended in the loss of billions of dollars and wealth destruction on a massive scale. An increasing number of people are involved in the stock market, especially since the social security and retirement plans are being increasingly privatized and linked to stocks and bonds and other elements of the market. There have been a number of famous stock market crashes like the Wall Street Crash of 1929, the stock market crash of 1973–4, the Black Monday of 1987, the Dot-com bubble of 2000. But those stock market crashes did not begin in 1929, or 1987. They actually started years or months before the crash really hit hard.

One of the most famous stock market crashes started October 24, 1929 on Black Thursday. The Dow Jones Industrial lost 50% during this stock market crash. It was the beginning of the Great Depression. Another famous crash took place on October 19, 1987 – Black Monday. On Black Monday itself, the Dow Jones fell by 22.6% after completing a 5 year continuous rise in share prices. This event not only shook the USA, but quickly spread across the world. Thus, by the end of October, stock exchanges in Australia lost 41.8%, Canada lost 22.5%, Hong Kong lost 45.8% and Great Britain lost 26.4%. Names “Black Monday” and “Black Tuesday” are also used for October 28-29,1929, which followed Terrible Thursday – starting day of the stock market crash in 1929. The crash in 1987 raised some mysticism – main news or events did not predict the catastrophe and visible reasons for the collapse were not identified. This event had put many important assumptions, of modern economics, under uncertainty, namely, the theory of rational conduct of human being, the theory of market equilibrium and the hypothesis of market efficiency. For some time after the crash, trading in stock exchanges worldwide was halted, since the exchange's computers did not perform well owing to enormous quantity of trades being received at one time. This halt in trading allowed the Federal Reserve system and central banks of other countries to take measures to control the spreading of worldwide financial crisis. In the United States the SEC introduced several new measures of control into the stock market in an attempt to prevent a re-occurrence of the events of Black Monday. Computer systems were upgraded in the stock exchanges to handle larger trading volumes in a more accurate and controlled manner. The SEC modified the margin requirements in an attempt to lower the volatility of common stocks, stock options and the futures market. The New York Stock Exchange and the Chicago Mercantile Exchange introduced the concept of a circuit breaker. The circuit breaker halts trading if the Dow declines a prescribed number of points for a prescribed amount of time.

Importance of stock market

Function and purpose

The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate.

History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption. Therefore, central banks tend to keep an eye on the control and behavior of the stock market and, in general, on the smooth operation of financial system functions. Financial stability is the raison d'être of central banks.

Exchanges also act as the clearinghouse for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction.

The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as employment. In this way the financial system contributes to increased prosperity.

Relation of the stock market to the modern financial system
The financial system in most western countries has undergone a remarkable transformation. One feature of this development is disintermediation. A portion of the funds involved in saving and financing flows directly to the financial markets instead of being routed via banks' traditional lending and deposit operations. The general public's heightened interest in investing in the stock market, either directly or through mutual funds, has been an important component of this process. Statistics show that in recent decades shares have made up an increasingly large proportion of households' financial assets in many countries. In the 1970s, in Sweden, deposit accounts and other very liquid assets with little risk made up almost 60 per cent of households' financial wealth, compared to less than 20 per cent in the 2000s. The major part of this adjustment in financial portfolios has gone directly to shares but a good deal now takes the form of various kinds of institutional investment for groups of individuals, e.g., pension funds, mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards forms of saving with a higher risk has been accentuated by new rules for most funds and insurance, permitting a higher proportion of shares to bonds. Similar tendencies are to be found in other industrialized countries. In all developed economic systems, such as the European Union, the United States, Japan and other developed nations, the trend has been the same: saving has moved away from traditional (government insured) bank deposits to more risky securities of one sort or another.

The stock market, individual investors, and financial risk

Riskier long-term saving requires that an individual possess the ability to manage the associated increased risks. Stock prices fluctuate widely, in marked contrast to the stability of (government insured) bank deposits or bonds. This is something that could affect not only the individual investor or household, but also the economy on a large scale. The following deals with some of the risks of the financial sector in general and the stock market in particular. This is certainly more important now that so many newcomers have entered the stock market, or have acquired other 'risky' investments (such as 'investment' property, i.e., real estate and collectables).

With each passing year, the noise level in the stock market rises. Television commentators, financial writers, analysts, and market strategists are all overtalking each other to get investors' attention. At the same time, individual investors, immersed in chat rooms and message boards, are exchanging questionable and often misleading tips. Yet, despite all this available information, investors find it increasingly difficult to profit. Stock prices skyrocket with little reason, then plummet just as quickly, and people who have turned to investing for their children's education and their own retirement become frightened. Sometimes there appears to be no rhyme or reason to the market, only folly.

This is a quote from the preface to a published biography about the long-term value-oriented stock investor Warren Buffett.[2] Buffett began his career with $100, and $105,000 from seven limited partners consisting of Buffett's family and friends. Over the years he has built himself a multi-billion-dollar fortune. The quote illustrates some of what has been happening in the stock market during the end of the 20th century and the beginning of the 21st.

The behavior of the stock market

From experience we know that investors may temporarily pull financial prices away from their long term trend level. Over-reactions may occur—so that excessive optimism (euphoria) may drive prices unduly high or excessive pessimism may drive prices unduly low. New theoretical and empirical arguments have been put forward against the notion that financial markets are efficient.

According to the efficient market hypothesis (EMH), only changes in fundamental factors, such as profits or dividends, ought to affect share prices. (But this largely theoretic academic viewpoint also predicts that little or no trading should take place—contrary to fact—since prices are already at or near equilibrium, having priced in all public knowledge.) But the efficient-market hypothesis is sorely tested by such events as the stock market crash in 1987, when the Dow Jones index plummeted 22.6 percent—the largest-ever one-day fall in the United States. This event demonstrated that share prices can fall dramatically even though, to this day, it is impossible to fix a definite cause: a thorough search failed to detect any specific or unexpected development that might account for the crash. It also seems to be the case more generally that many price movements are not occasioned by new information; a study of the fifty largest one-day share price movements in the United States in the post-war period confirms this.[3] Moreover, while the EMH predicts that all price movement (in the absence of change in fundamental information) is random (i.e., non-trending), many studies have shown a marked tendency for the stock market to trend over time periods of weeks or longer.

Various explanations for large price movements have been promulgated. For instance, some research has shown that changes in estimated risk, and the use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could cause financial markets to overreact.

Other research has shown that psychological factors may result in exaggerated stock price movements. Psychological research has demonstrated that people are predisposed to 'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes in clouds or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investor's self-confidence, reducing his (psychological) risk threshold.[4]

Another phenomenon—also from psychology—that works against an objective assessment is group thinking. As social animals, it is not easy to stick to an opinion that differs markedly from that of a majority of the group. An example with which one may be familiar is the reluctance to enter a restaurant that is empty; people generally prefer to have their opinion validated by those of others in the group.

In one paper the authors draw an analogy with gambling.[5] In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically.

The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. In the period running up to the recent Nasdaq crash, less than 1 per cent of the analyst's recommendations had been to sell (and even during the 2000 - 2002 crash, the average did not rise above 5%). The media amplified the general euphoria, with reports of rapidly rising share prices and the notion that large sums of money could be quickly earned in the so-called new economy stock market. (And later amplified the gloom which descended during the 2000 - 2002 crash, so that by summer of 2002, predictions of a DOW average below 5000 were quite common.)

Irrational behavior

Sometimes the market tends to react irrationally to economic news, even if that news has no real effect on the technical value of securities itself. Therefore, the stock market can be swayed tremendously in either direction by press releases, rumors, euphoria and mass panic.

Over the short-term, stocks and other securities can be battered or buoyed by any number of fast market-changing events, making the stock market difficult to predict.

History

Historian Fernand Braudel suggests that in Cairo in the 11th century Muslim and Jewish merchants had already set up every form of trade association and had knowledge of many methods of credit and payment, disproving the belief that these were invented later by Italians. In 12th century France the courratiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. Because these men also traded with debts, they could be called the first brokers. In late 13th century Bruges commodity traders gathered inside the house of a man called Van der Beurse, and in 1309 they became the "Brugse Beurse", institutionalizing what had been, until then, an informal meeting. The idea quickly spread around Flanders and neighboring counties and "Beurzen" soon opened in Ghent and Amsterdam.

In the middle of the 13th century Venetian bankers began to trade in government securities. In 1351 the Venetian government outlawed spreading rumors intended to lower the price of government funds. Bankers in Pisa, Verona, Genoa and Florence also began trading in government securities during the 14th century. This was only possible because these were independent city states not ruled by a duke but a council of influential citizens. The Dutch later started joint stock companies, which let shareholders invest in business ventures and get a share of their profits - or losses. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds.

The Amsterdam Stock Exchange (or Amsterdam Beurs) is also said to have been the first stock exchange to introduce continuous trade in the early 17th century. The Dutch "pioneered short selling, option trading, debt-equity swaps, merchant banking, unit trusts and other speculative instruments, much as we know them" (Murray Sayle, "Japan Goes Dutch", London Review of Books XXIII.7, April 5, 2001). There are now stock markets in virtually every developed and most developing economies, with the world's biggest markets being in the United States, Canada, China (Hongkong), India, UK, Germany, France and Japan

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History of stock market trading in the United States can be traced back to over 200 years ago. Historically, The colonial government decided to finance the war by selling bonds, government notes promising to pay out at profit at a later date. Around the same time private banks began to raise money by issuing stocks, or shares of the company to raise their own money. This was a new market, and a new form of investing money, and a great scheme for the rich to get richer. A little further on the history timeline, more specifically in 1792, a meeting of twenty four large merchants resulted into a creation of a market known as the New York Stock Exchange(NYSE). At the meeting, the merchants agreed to meet daily on Wall Street to daily trade stocks and bonds.

Further in history, in the mid-1800s, United States was experiencing rapid growth. Companies needed funds to assist in expansion required to meet the new demand. Companies also realized that investors would be interested in buying stock, partial ownership in the company. History has shown that stocks have facilitated the expansion of the companies and the great potential of the recently founded stock market was becoming increasingly apparent to both the investors and the companies.

By 1900, millions of dollars worth of stocks were traded on the street market. In 1921, after twenty years of street trading, the stock market moved indoors.

History brought us the Industrial Revolution, which also played a role in changing the face of the stock market. New form of investing began to emerge when people started to realize that profits could be made by re-selling the stock to others who saw value in a company. This was the beginning of the secondary market, known also as the speculators market. This market was more volatile than before, because it was now fueled by highly subjective speculation about the company’s future.

This was the pretext for appearance of such stock market giants as NYSE. History books tell us that the reason the NYSE is so highly regarded among stock markets was primarily because they only trade in the very large and well-established companies. It acted as a more stable investment alternative, for people interested in throwing their capital into the stock market arena. The smaller companies making up the stock market formed into what eventually became the American Stock Exchange (AMEX). Contrary to the 80-year old history, today the NYSE, AMEX, NASDAQ and hundreds of other exchange markets make a significant contribution to the national and global economy.

The growth in the number of market participants led the government to decide that more regulation of the stock market was needed to protect those investing in stock. History was made in 1934, when following the Great Crash, Congress passed the Securities and Exchange Act. This act formed the Securities and Exchange Commission (SEC), which, through the rules set out by the act and succeeding amendments, regulates American stock market trading with the help of the exchanges. It also includes overseeing the requirements for a company to issue stock shares to the public and ensures that the company offers relevant information to potential investors. The SEC also oversees the daily actions of market exchanges and how they trade the securities offered.

Although historically, investing in stocks was a “hobby” for the rich, an average person too soon came to realize the value of the investing in stocks vs. traditional assets like land or a house.

Market participants

Many years ago, worldwide, buyers and sellers were individual investors, such as wealthy businessmen, with long family histories (and emotional ties) to particular corporations. Over time, markets have become more "institutionalized"; buyers and sellers are largely institutions (e.g., pension funds, insurance companies, mutual funds, hedge funds, investor groups, and banks). The rise of the institutional investor has brought with it some improvements in market operations. Thus, the government was responsible for "fixed" (and exorbitant) fees being markedly reduced for the 'small' investor, but only after the large institutions had managed to break the brokers' solid front on fees (they then went to 'negotiated' fees, but only for large institutions)

However, corporate governance (at least in the West) has been very much adversely affected by the rise of (largely 'absentee') institutional 'owners'

International trade definition

What is Trading ??

We can say It's , Participants in the stock market range from small individual stock investors to large hedge fund traders, who can be based anywhere. Their orders usually end up with a professional at a stock exchange, who executes the order.

Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry. This type of auction is used in stock exchanges and commodity exchanges where traders may enter "verbal" bids and offers simultaneously. The other type of exchange is a virtual kind, composed of a network of computers where trades are made electronically via traders.

Actual trades are based on an auction market paradigm where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. (Buying or selling at market means you will accept any ask price or bid price for the stock, respectively.) When the bid and ask prices match, a sale takes place on a first come first served basis if there are multiple bidders or askers at a given price.

The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace (virtual or real). The exchanges provide real-time trading information on the listed securities, facilitating price discovery.

The New York Stock Exchange is a physical exchange, also referred to as a listed exchange — only stocks listed with the exchange may be traded. Orders enter by way of exchange members and flow down to a specialist, who goes to the floor trading post to trade stock. The specialist's job is to match buy and sell orders using open outcry. If a spread exists, no trade immediately takes place--in this case the specialist should use his/her own resources (money or stock) to close the difference after his/her judged time. Once a trade has been made the details are reported on the "tape" and sent back to the brokerage firm, which then notifies the investor who placed the order. Although there is a significant amount of human contact in this process, computers play an important role, especially for so-called "program trading".

The NASDAQ is a virtual listed exchange, where all of the trading is done over a computer network. The process is similar to the New York Stock Exchange. However, buyers and sellers are electronically matched. One or more NASDAQ market makers will always provide a bid and ask price at which they will always purchase or sell 'their' stock.

The Paris Bourse, now part of Euronext, is an order-driven, electronic stock exchange. It was automated in the late 1980s. Prior to the 1980s, it consisted of an open outcry exchange. Stockbrokers met on the trading floor or the Palais Brongniart. In 1986, the CATS trading system was introduced, and the order matching process was fully automated.

From time to time, active trading (especially in large blocks of securities) have moved away from the 'active' exchanges. Securities firms, led by UBS AG, Goldman Sachs Group Inc. and Credit Suisse Group, already steer 12 percent of U.S. security trades away from the exchanges to their internal systems. That share probably will increase to 18 percent by 2010 as more investment banks bypass the NYSE and NASDAQ and pair buyers and sellers of securities themselves, according to data compiled by Boston-based Aite Group LLC, a brokerage-industry consultant

Now that computers have eliminated the need for trading floors like the Big Board's, the balance of power in equity markets is shifting. By bringing more orders in-house, where clients can move big blocks of stock anonymously, brokers pay the exchanges less in fees and capture a bigger share of the $11 billion a year that institutional investors pay in trading commissions

What is the International trading ??

International trade is the exchange of capital, goods and services across international boundaries or territories.In most countries, it represents a significant share of GDP. While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced Transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. International trade is a major source of economic revenue for any nation that is considered a world power. Without international trade, nations would be limited to the goods and services produced within their own borders.

International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade does not change fundamentally depending on whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or a different culture.

Another difference between domestic and international trade is that factors of producion such as capital and labor are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in good and services can serve as a substitute for trade in factors of production. Instead of importing the factor of production a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor.

International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.

Stock market definition

stock market, or (equity market), is a private or public market for the trading of company stock and derivatives of company stock at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.

The size of the stock market is estimated at about $51 trillion. The world derivatives market has been estimated at about $480 trillion face or nominal value, 30 times the size of the U.S. economy. and 12 times the size of the entire world economy. It must be noted though that the value of the derivatives market, because it is stated in terms of national values, and cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value . Many such relatively illiquid securities are valued as marked to model, rather than an actual market price.

The stocks are listed and traded on stock exchanges which are entities a corporation or mutual organization specialized in the business of bringing buyers and sellers of stocks and securities together. The stock market in the United States includes the trading of all securities listed on the NYSE, the NASDAQ, the Amex, as well as on the many regional exchanges, e.g. OTCBB and Pink Sheets. European examples of stock exchanges include the Paris Bourse, now part of Euronext, theLondon Stock Exchange and the Deutsche.

Or in other simpler definition

The market in which shares are issued and traded either through exchanges or over-the-counter markets. Also known as the equity market, it is one of the most vital areas of a market economy as it provides companies with access to capital and investors with a slice of ownership in the company and the potential of gains based on the company's future performance.

Notes:

This market can be split into two main sections: the primary and secondary market. The primary market is where new issues are first offered, with any subsequent trading going on in the secondary market.

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Allot Easyer Definition

Plain and simple, a “stock” is a share in the ownership of a company.

A stock represents a claim on the company's assets and earnings. As you acquire more stocks, your ownership stake in the company becomes greater.

Note: Some times different words like shares, equity, stocks etc. are used. All these words mean the same thing.