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Chapter 1: Stock as a Wealth Tool

Have you ever wanted to be your own boss? Imagine if you could build a
reliable source of income from the comfort of your own home, and spend
your time watching your money grow! It might sound like an impossible
goal, but it’s a reality for many people who successfully trade on the stock
market.
Stocks are one of the greatest tools ever created for building wealth. If you
plan on investing and growing your money, knowing how to successfully
trade on the stock market is mandatory. Stocks make up the majority of
almost every investment portfolio, and can be a great way to store and grow
your capital.

Years ago, only the rich were able to trade on the stock market, and they used
it to amass fortunes. Nowadays, thanks to advances in technology and
education, the stock market is available to almost everyone. There’s never
been a better time to start trading.
Regardless of how popular stocks have become, most people still don’t
understand how stocks work. On top of the lack of information, there’s also a
lot of bad information and advice, given by people who don’t know what
they’re talking about. A lot of this information is based on the “get rich
quick” mentality, where others will urge you to invest everything into a
certain company, or make constant risky decisions. The stock market is not a
casino, and you shouldn’t be risking any large amounts of money. If you play
the stock market carefully and consciously, it’s very possible to make a
constant return that will grow your wealth to new heights. The best way to
protect your money in the stock market is to understand where you are
putting your money.

That’s why I’ve created this guide, to give you the knowledge you need to
make smart investment decisions. I’ll begin by explaining the basics of stocks
and the different types of stocks, and then will cover how they’re traded, and
what causes prices to fluctuate.
Chapter 2: Basics of Stocks

What is a Stock?
In layman terms, a stock is representative of a single share in the ownership
of a company. A stock is a claim on a company’s earnings and assets. The
more stock you own, the more of the company you own. For example if you
buy 51% of a company’s stock, than you own the majority of the company
itself, and are entitled to most of its profits and assets.

Stock Owner Rights


By owning stock, you become one of the many shareholders who direct the
company. This means that you are entitled to any voting rights associated
with the stock, and your influence in the company increases with every stock
you buy. You won’t be able to influence the day to day actions of a company;
however you can influence its direction by voting to elect people to the board
of directors at annual meetings.
The management of a company is supposed to increase profit for
shareholders. That is their main responsibility, and those who don’t are often
voted out. However, for most major companies, there are such a large amount
of shares that the average person won’t have much influence. For any fortune
500 company, the only entities that could make an impact are billionaire
investors and large funds. However if the majority of voters are of the same
mind, they can make a massive impact even if it goes against the wishes of
the other larger shareholders, as long as their combined % of ownership is
larger than the other voters.
Prior to the popularity of online brokers, a stock would be represented by a
stock certificate. This was a piece of paper that provided proof that you
owned the stock. Nowadays this type of information is stored electronically
by your online broker. This is good, because it makes the shares easier to
trade. With a click of a mouse or a simple phone call, now you can trade
instantly to take advantage of any potential opportunities.
However, most shareholders don’t concern themselves with trying to manage
or influence the company. The great thing about stocks is that you can profit
off them passively, with very little work. The main benefit to a stock is the
share of the profit that you’re entitled to. Profits are paid out in dividends,
which is the amount of profit distributed per stock. The more stock, the more
profits. As for your ownership of assets, this only comes into play if the
company becomes bankrupt. In the case of a bankruptcy, all the company’s
assets will be liquidated. First the creditors (people who the company owes
money to) will be paid, and what’s left will be distributed among the
shareholders.

At this point you’re probably wondering “If a stock means I own part of a
company, does that mean I’m liable to pay their debts as well?” The answer
is no, thanks to an excellent feature of stocks called limited liability. As
opposed to a partnership, where if the partnership goes bankrupt creditors can
go after the partner’s assets personally, stockholders are completely shielded
from any liability. When you buy a stock, the maximum amount of money
you can lose is your initial investment. If you buy 1 stock at $90, you will
never lose more than $90. This creates an excellent situation where you are
entitled to all the profits of a business, and none of the debts. Although any
debt the company has will lower the prices of the stock and cost you money
indirectly, you can always sell the stock and move on.
Chapter 3: Why Stocks Exist

Why do Stocks Exist?


At some point, everyone asks the questions, “Why do stocks even exist?” If a
company is profitable, why would they want to share their profits with
hundreds or thousands of people? The answer is to raise money. At some
point, every company wants to raise money to finance their future
endeavours. They can do this either by borrowing money or selling parts of
the company in the form of stocks. Borrowing money, or issuing bonds with
a guarantee to pay back, is known as debt financing. Selling stock is known
as equity financing.
Oftentimes, selling stock is the best idea financially since it doesn’t require
the company to be burdened by debt repayments, or to make interest
payments. The first sale of a stock is called the initial public offering, or IPO.
All that shareholders get in exchange for their money is the hope that the
stock will go up, and the company will be profitable enough to pay out
dividends.

There is a big difference between a company financing through debt, and


financing through the selling of shares. If you purchase debt in the form of a
bond, you’re guaranteed the return of your initial payment, as well as interest
payments. This isn’t the case with a stock. By purchasing stock and
becoming a shareholder, you will be taking on the risk that the company will
fail, and you might potentially lose your initial investment. Also if the
company becomes bankrupt, you will be paid only after the creditors have
been paid. So if someone has bought a bond from the company, they will be
paid first before any shareholders are paid. If a company is successful there’s
opportunity for long term profits and growth, however if it fails then you
stand to lose whatever capital you invested into that company.
How Much are You Willing to Risk?
It’s important to remember that when it comes to individual stocks, there are
no guarantees of profitability. While you might make predictable income on a
large spread of stocks if you invest intelligently, you should never bet a large
amount of your capital on a single stock. Even if you have good reasons to
believe that a certain company will be increasing in value soon, there’s no
such thing as a “sure thing” and multiple foolish investors have lost fortunes
betting on a single company. It’s important to diversify your stocks. You
should also keep in mind that while most companies pay out dividends, some
of them won’t, or will only pay them irregularly. In that situation, it’s
important to only invest if you have reason to believe the stock will go up. If
a company pays dividends regularly, than even if you think the stock will
stay at the same price, it can still be a good idea to buy for the dividends and
sell later at the same price.
Although risk should in general be minimized, that’s not to say that all risk is
bad. Every trade you make involves some level of risk, and in general the
higher the degree of risk the larger the profit there is to be made. Stocks have
historically produced a return of 10-13% per year, ever year. This beats the
rate of inflation significantly, and is a great indicator of the profitability of
stocks.

Now, let’s talk about the two types of stock. There’s common stock, and
preferred stock. Both are important, however they both have significant
differences.
Chapter 4: Types of Stocks

Common Stock

Common stock is, as the name suggests, the most common type of stock.
When people refer to stock, this is what they mean most of the time. This
type of stock represents ownership of a specific percentage of a company,
and an entitlement to your share of the company’s profit. Owners of this type
of stock get one vote per share when it comes time to elect members of the
board, who make major decisions concerning the company.
Stocks provide a greater return on your initial investment than almost any
other type of investment on average. However stocks are also one of the more
risky investment instruments, since you run the chance of losing your initial
capital if you don’t invest wisely.

Preferred Stock

Preferred stock is similar to common stock, with certain key differences. The
two main differences are that with preferred stock, you don’t have the same
voting rights in a company, if at all. Secondly, the dividends paid to you are a
fixed amount. With common stock your dividends are a percentage of profit
per share, and so the amount of dividend paid varies depending on how well
the company does financially. With preferred stock, you receive the same
amount of money every quarter regardless of how the company does. This
can be a good thing or a bad thing depending on whether or not the company
in question starts underperforming or not. People with preferred stock are
also paid before people with common stock in the event of bankruptcy or
liquidation; however they are still paid after the creditors. Preferred stock is
considered a mixture of debt and equity, and it’s helpful to view them as
somewhere in between bonds and normal shares.
Different Strands of Stock
Although common and preferred stock are the two main types, there are also
ways for companies to customize specific types of stock in virtually any way
they want. One of the most common reasons for doing this is so that voting
rights remain within a certain group, and to accomplish this companies issue
different classes of shares with different voting rights. As an example, a
company might issue a certain type of share that gives 10 votes per share to a
select few, and another that only gives 1 vote per share to the majority.
When a company issues multiple types of stock, they are designated as Class
A, Class B, and so on. The different types are shown by placing the letter
behind the normal ticket symbol, for example instead of BAC it would be
shown as BAC.A, and BAC.B.

The majority of stocks are bought and sold on exchanges, which is a place
where sellers and buyers meet and decide on a price. Exchanges can be
physical locations where deals are made on the trading floor, for example the
New York Stock Exchange. This is the one you see in movies often, with
traders yelling loudly and running to make deals. Exchanges can also be
virtual, made up of multiple computer networks where trades are finalized
electronically from the comfort of your own home.
Exchanges are necessary to facilitate the exchange of shares between buyers
and sellers. Imagine if you had to search around to find someone with the
type of stock you want!

Prior to continuing, it’s important to clarify the difference between a primary


market and a secondary market. The primary market is where the securities
are initially traded, in the form of an IPO (as mentioned earlier), whereas in
the secondary market investors trade securities that were already sold without
any involvement of the original company.

The New York Stock Exchange


The largest and most influential primary exchange in the entire world is The
New York Stock Exchange. This stock exchange is over 200 years old,
created only a few decades after the founding of The United States. The
largest companies in the US list themselves on the NYSE.
The NYSE was the first exchange of its kind, where the majority of the trades
were conducted face to face on a trading floor. Orders are received from
brokerage firms that are members of the exchange, and those orders make
their way down to the trading floor where the desired stock is traded. At each
of these locations there’s a person called the specialist, whose responsibility
it is to match traders with sellers and vice versa. An “auction method” is used
to determine prices, where the price at any given time is highest amount a
buyer will pay for the stock, and the lowest amount price that someone will
sell it at. After the trade is completed, the information is sent to the brokerage
firm, who passes on the news to the investor who requested the trade initially.

The NASDAQ

The second type of exchange is the NASDAQ. You’ve probably heard this
referred to on the news, and it is a very important exchange. This exchange is
completely virtual, with no central location or floor for traders to physically
trade on. All trading is done through computers and the networks of dealers.
Years ago, the largest companies were traded through the NYSE while less
valuable companies were sold through the NASDAQ. However since the tech
boom in the late 90’s, the NASDAQ now is the place to go to buy dozens of
massive companies, such as Intel, Dell, Microsoft and others. This increase in
importance has made the NASDAQ a competing force, and a place where all
the biggest investors come to trade.
Chapter 5: Other Types of Exchange

Other Exchanges

Coming in third in terms of size is the AMEX, or the American Stock


Exchange. While the AMEX used to be considered as an alternative to the
NYSE, that has changed since the popularity of the NASDAQ. In fact, the
owners of NASDAQ, the National Association of Securities Dealers, have
bought Amex.
There are multiple stock exchanges in almost every country that exists in the
world. While US markets are the largest, they are just one part of the world
market that buys and sells stocks. There are other major stock exchanges such
as the London Stock Exchange, and the Hong Kong Stock Exchange. The
world turns to these major exchanges to see future trading trends, and make
analysis of where the market is heading. Lastly, there is the OTCBB or over
the counter bulletin board. This is the home to penny stocks other risky
stocks, since there is almost no regulation present. Avoid trading in penny
stocks at all costs, as they are rife with scams.
Stock prices are constantly fluctuating based on market demands. Stocks are
influenced only by supply and demand, which is a very basic concept. Don’t
be fooled however, because supply and demand are influenced by 100’s of
different factors. Sometimes a simple rumour is enough to crash the price of a
stock! The more people who want to buy a stock, the higher the price goes.
The more people want to sell, the faster the price will. It is often said that
trading stocks takes a day to learn, but years to master. This is true, and after
you learn the basics of trading it will take a lot of practice before you make a
living off buying and selling stocks full time.

The important thing to understand is what makes investors like certain stocks,
and dislike other stocks. Basically you need to understand what type of news
is going to add value to a company, and what type of news is going to create
unease and drive the prices down. This varies widely based on what type of
company you’re looking to invest in. The indicators for a tech company are
going to be different than a lumber company, since they both have their own
intricacies. The best advice I can give is to research each company
individually, and consult with a financial advisor if possible.

It’s also important not to confuse a company’s stock price with the value of
the company. If one company sells stock for $100 a share and another
company sells it for $10 a share, this doesn’t mean the first company is worth
more if they issued less than 10x the stock of the second company. The price
of a share multiplied by the amount of shares is called the market
capitalization. For example:

Company X issues 5000 shares at $100 each. Total market capitalization is


$500,000.

Company Y issues 500000 shares at $10 each. Total market capitalization is


$5,000,000.

A company’s stock price doesn’t just include the current value of a company;
it also includes expectations of future growth. For example if most investors
feel a company’s stock will double in price over the next 10 years, the stock
price will almost double even though the company hasn’t actually created any
more value yet. So if someone invests in that company at its inflated price
and the company does as well as expected, that person won’t make any
money since the stock price had already taken the growth into account.

By far, the most important indicator of a company’s value is its earnings.


Earnings are just another word for profit, and of course increasing profit is
the primary goal for any publically listed company. If a company fails to
return a profit, it won’t stay in business. Earning reports are released
quarterly, four times a year. Each earning report will have an impact on the
stock price, so it’s very important to be up to date with information if you’re
heavily invested in a certain company. If a company does better than
expected its price will rise, and if it does worse than expected its price will
drop. If its earnings are in line with past predictions, it will stay at its current
level.

Obviously, it’s not just profits that can change the price of a stock. It would
be very simple to invest if that was the case! A great example of this is the
dotcom bubble, in which hundreds of internet based companies had market
capitalizations in the billions, without making a single dollar. Their market
capitalization was based on the expectation of future earnings, and in most
cases these future earnings didn’t happen. This lead to many people losing
fortunes overnight.

Most investors have a system they use to determine if a stock is going to rise
in price, which only has current and past profits as a single component.
Examples range from simple systems such as the price/earnings ratio, to
incredibly complicated systems such as the moving average convergence
divergence system. While systems can be a helpful tool, they should never be
relied on completely. If you’re just starting out trading, you should be basing
your trades on a sound knowledge of the company, not on any sort of trading
system.

When you’re starting out trading, here are the most important factors to
remember. If you can grasp the following concepts, you will be miles ahead
of your competition and starting on firm ground.

The basic concepts to remember before you start trading are the following:

Supply and demand in the market determines the stock price, nothing else.
The price of a share multiplied by the amount of shares issued is the value of
a company, commonly referred to as market capitalization. Just comparing
the stock price of two different companies is meaningless and misleading.
Although current and projected future profits are the main movers of stock
price, the price can vary based on hundreds of different factors. It’s important
to consider investor’s expectations, the future of the companies industry, and
any other factor that might influence the price of a stock. Major events such
as wars or natural disasters will almost always influence the price of a stock if
it is based in the country the event is happening.
Try not to get too caught up in theories or systems that try to explain the way
stock prices move. There is no single system that will ever predict the future
price of a stock.
Never trade in penny stocks, or other high risk stocks. Many people try to out
of greed, but if you do this you might as well go to the casino and put all your
money on black.
Stock is a percentage of ownership. As a shareholder, you have a right to the
earnings and assets of a company, as well as voting rights for common
stocks.
Stocks are equity, bonds are debt. Bondholders are guaranteed a return on
their investment, and stockholders are not. Although stocks have the greatest
potential for profit, they also have a higher risk associated with them.
It is possible to lose all your money invested in a stock. While rare, it can
happen and so you should never put all your capital into a single investment
unless you’re willing to lose it. On the flip side it is also possible to make
fortunes with the right investment.
Common stock provides dividends based on the profits made by the
company, and preferred stock provides a fixed dividend.

If you understand these basic concepts, you’ll be well on your path to


becoming a successful trader. There’s nothing else to do but start trading!