The stock market makes an appearance in the news every day. You hear about it when it reaches a new high, in headlines like "The Pakistan Stock Exchange Average rose 50 index points today", when a certain stock plummets, or when the political scenario changes.
Obviously, stocks and the stock market are important, but you may find that you know very little about them. What is a stock? What is a stock market? Why do we need a stock market? Where does the stock come from to begin with, and why do people want to buy and sell it? If you have questions like these, you've come to the right place.Welcome to a whole new world.
The Basic Idea
Stocks in publicly traded companies are bought and sold at a stock market (also known as a stock exchange). The Pakistan Stock Exchange (PSX) is an example of such a market.
In your neighborhood, you probably have a supermarket that sells groceries. The reason you go the supermarket is because everything you need to run your home is available under one roof. It's far more convenient than having to make 10 stops at different stores.
The PSX is a supermarket for stocks. The PSX is like a big room where everyone who wants to buy and sell shares can go to conduct their transactions.
The Exchange makes buying and selling easy. You do not have to actually travel to the Stock Exchange; rather, you can call a stock broker who does business with the Exchange, and he or she will go there on your behalf to buy or sell your stock. With an Exchange in place, you can buy and sell shares instantly.
The Stock Exchange has an interesting side effect. Because all the buying and selling is concentrated in one place, it allows the price of a stock to be known every second of the day. Therefore, investors can watch as a stock's price fluctuates based on news from the company, media reports, economic news and a range of other factors. Smart buyers and sellers take all of these factors into account before making decisions.
If you start a business using your own money, you have formed a sole proprietorship. You own the entire business yourself. If three people pool their money together and start a business as a team, they have formed a partnership. The three people own the business, sharing the profit and decision-making.
Any business that wants to sell shares of stock to a number of different people does so by turning itself into a corporation. The process of turning a business into a corporation is called incorporation.
A corporation is different, and it is an interesting concept. A corporation is a "virtual person." That is, a corporation is registered with the government, it has a tax number, it can own property, it can go to court, and it can enter into contracts. By definition, a corporation has stock that can be bought and sold, and all of the owners of the corporation hold shares of stock in the corporation to represent their ownership. One incredibly interesting characteristic of this "virtual person" is that it has an indefinite and potentially infinite life span.
There is a whole body of law that controls corporations. These laws are in place to protect shareholders and the public. These laws control a number of things about how a corporation operates and is organized. For example, every corporation has a board of directors. The shareholders in the company meet every year to vote on the people for the board. The board of directors makes the decisions for the company. The board of directors can be thought of as the brain of the virtual person.
The owners of a corporation gain ownership by buying shares of stock in the corporation. The board of directors decide how many total shares there will be. For example, a company may have one million shares of stock. The company can either be privately held or publicly held. In a privately held company, the shares of stock are owned by a small number of people who probably all know one another. They buy and sell their shares amongst themselves. A publicly held company is owned by thousands of people who trade their shares on a public Stock Exchange.
A corporation is an easy way to gather large quantities of investment capital. When a corporation first sells stock to the public, it does so in an IPO (Initial Public Offering). The company might sell one million shares of stock at Rs. 20 a share to raise Rs. 20 million very quickly. The company then invests the 20 million rupees in equipment and employees. The investors who bought the stock hope that with the equipment and employees, the company will make a profit and pay a dividend.
Stock Exchanges in Pakistan
Out of all the three Exchanges, the Pakistan Stock Exchange is the premiere Stock Exchange of the country, with over 644 listed companies. It was established soon after the creation of Pakistan.
When people talk about investing, they think of putting money into a company stock and holding it for a long time until they realize a significant gain. From this view, put simply, investing is to "buy and hold." In reality, people also use the term "invest" to describe mid-term and long-term stock acquisition. Mid and long-term investors will study stock fundamentals such as a company's quarterly earnings report, a company's relative strength in its industry sector, new product lines, technological innovation, or new management teams or strategies. They also look at stock charts and use basic technical analysis combined with overall market conditions to determine an entry point. Then, having done all this, they may sit back without worrying too much about short-term market fluctuation.In another form of trading, short-term traders attempt to buy low and sell high, not focusing as much on company fundamentals as long-term investors tend to do. Short-term traders may seem to care very little about conventional indicators. What they do care about is market volatility, the rising and falling of stock values, for the more ups and downs a stock has, the more money they believe they can make, getting in and out fast to take a quick profit.
An investment portfolio is an investor's collection of investments. A portfolio is a list of the total number of investments an individual investor holds. A diversified portfolio contains assets from a number of different sectors.
Every investor should know that there is a tradeoff between risk and reward: To obtain greater expected returns on investments, one must be willing to take on greater risk.
Portfolio management is all about the art and science of making decisions about an investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk vs. performance.
The main difference between an amateur and an experienced trader is that the latter always tries to understand and control portfolio risks. Before entering into any trade, good traders first think about how much risk to take and how much risk exposure comes with a particular trade selection. Only then do they allow themselves to think about how much profit they stand to make. Smart investors always cut down their position and exposure if they determine that a portfolio carries too much risk. They calculate this all-important estimation by employing Risk Management defined as that set of methods and procedures taken to estimate, and control risk for the purpose of achieving optimal investment results.
How to be a Successful Investor
One successful investor who made a lot of money defined stock trading as a challenging game of strategy and discipline. The stock market is vastly complex and dynamic, so you need to exercise strict discipline, clear judgment, do your homework, and set firm goals and limits. Sometimes the most important work you can do is exercising patience, confidence, and discipline. You need to stay calm, keeping your mind clear and focused. You can't blindly bet that the stock price will go up or go down. You need to be well informed and make buy or sell decisions based on facts and logic.
In investing, intuition also plays an important role. Good intuition comes from experience and sound judgment. When you start making money, you cannot think of yourself as a winner yet because if you lose focus and become greedy, you can lose your money in an instant. More importantly, if you happen to lose money, you cannot let yourself conclude that a single loss makes you a loser. Losing money can be very upsetting, but you need to be consistent and not quit the game easily. Learn to use a loss as a lesson, just as professional traders do, and determine why you lost. In this way, you maximize your chances of becoming a better investor. Talk with your friends and listen closely to trading tips, but in the end, you have to make your own judgments. Believe in yourself. If your next pick ends up being wrong, that may mean you have not yet done sufficient homework on that stock.
Conducting research is the most important thing to do before any trade. By doing your own research, you complete a definite set of steps that will guide you towards a successful outcome. First of all, set your goals: Do you want to trade long-term, mid-term or short-term? Once you have set your targets, stay with your plan.
After you have identified your goal, you will need to concentrate on specific industry sectors. By diversifying in a couple of different sectors you avoid putting all your eggs into a single basket. Within each sector, choose stocks you want to invest in. Ask yourself questions such as, why do I want to buy this particular stock. Does it have leading-edge products or technologies that I believe are going to fly? Or does the stock follow technical patterns well? In other words, does the stock chart follow a model? Positive responses to these questions can help you feel comfortable in investing in that stock.
Diversification means creating an investment portfolio that contains different types of investments within each of the major classes. A diversified portfolio might include stock in several different companies or a number of stock mutual funds, government and corporate bonds. You might diversify a larger portfolio even further by including a range of investments from other asset classes, such as real estate.
Reasons to Diversity
Taking Advantage of Market Conditions
Each of the traditional asset classes tends to produce its strongest returns under different market conditions than the other asset classes do. For example, stocks often shine when corporate earnings are strong and financial markets are expanding.
If your investments are narrowly focused, for example, if you own stock in just one company or stock in three companies in the same industry or area of the economy, the value of your portfolio can drop sharply if that company or industry produces disappointing returns. But if you own stocks of different-sized companies in different parts of the economy, even if some investments go down in value, others may remain stable or go up. In any case, different types of stocks are not as likely to lose value at the same rate or at the same time.
Finding the Right Balance
Diversification is not just about increasing the sheer number of your investments. It is about striking a balance among various investments in your portfolio to reduce your exposure to risk and take advantage of the full range of opportunities in the market. First, you need to analyze what you already own before you make another investment. Then you can identify the categories that you need to build up.
For example, if all of your stock investments are in large company stocks, it may be time to investigate some smaller company stocks, since they tend to perform differently and rise and fall in value at different times than larger company stocks. In this way, you can offset some of the risks that each investment carries on its own, while enjoying many of the advantages and benefits of each category of investment.