Your stock market questions answered
 

In the "How ignorant are you" thread, several people have stated that they don't understand the financial world or the stock market, and so a new thread is born.

the world of investing is not that difficult to understand so here, in this very thread, every question you've ever had will be answered by the Cellar's very own....Jaguar.

he may not appreciate that, so i'll post replies to questions as i can. obviously somethings i can't talk about like specific recommendations and such...but other people can, so what the hell.

if you've got questions - shout 'em out.

The first thing: If you own STOCK, it means you literally own a portion of that company. you may have a physical certificate, but that is being phased out in favor of electronic registration. Stock is generally bought and sold on the open market. Transactions are generally completed through one of the exchanges, or clearing houses. (New York Stock Exchange, American Stock Exchange, etc.)

The little numbers change all the time, because thousands and sometimes millions of shares of a specific stock are traded in a number of different transactions. each transactions may have been for a different purchase price that can change based on supply/demand as influenced by market conditions.

I know that there are ways to make money on stock that you think a stock is going to go down, instead of up, but I don't really have a solid grasp of how it works. You somehow buy a contract with a right to buy, or a right to sell at a certain price, or something, right?

-sm

you also may have been speaking about SELLING SHORT. that is a little less complicated than options.

I don't own ABC, co which is trading at $50. i think it is going to fall to $40 in the near future. I sell "short" 1000 sh of ABC at $50. effectively i have taken a loan without a specific repayment schedule. It does have to be repaid though. if ABC drops to $40 i will buy 1000 sh of it to cover my short position, effectively repaying my debt to the person that loaned the sold shares to me. if however, ABC, co goes to $60, i still have to, at some point, cover my position and buy the shares which may result in a drastic loss. generally you don't sell short without some sort of LIMIT order set.

I heard a description of something once where (if you thought a stock was going to go down,) you could basically "borrow" someone else's shares, sell them, then when the price went down buy them back and give the guy the shares back, thus pocketing the difference in what you bought it back for.

Is that just an inaccurate analogy for a Call, or is that something different?

sorry, i split it into two posts. that is effectively what SELLING SHORT is.

How come there is always a buyer for a seller, even when a stock is tanking miserably? Are there ever transactions that don't complete? (not including intervention by the SEC, say when they shut down trading on a stock that's that bad.)

What are the guys in the different color coats doing down there on the trading floor?

:worried: Ok I'm lost already.

Definitions please:

1. "open market"

2. "The little numbers change all the time, because thousands and sometimes millions of shares of a specific stock are traded in a number of different transactions. each transactions may have been for a different purchase price that can change based on supply/demand as influenced by market conditions."

What market conditions? Why does the amount of transactions affect the price? Why are there different purchase prices? How do they know? Who decides the prices? How can market conditions be measured that quickly and precisely? Are companies at all in control of supply and demand - is it based on annual performance or predictions?

I want to ask about the other stuff but this is enough for my little head right now.

Good idea for a thread btw.

I enjoy this stuff so I will write an analogy. Sorry folks, this is long.

I have a classic automobile, the "1948 Toadie" which I have in storage. It's kind of rare, and in excellent condition, and I bought it for 50000 shekels. It'll probably go up in value.

I can't really afford to have such a nice expensive thing, so I decide, I'm going to break it up and offer people an "investment" in my auto. I take 100 pieces of paper, and on each one I write a little contract that says the owner of the piece of paper also owns 1/100th of the car.

I take 51 of the pieces and put them in a lock box, and then I go and sell the other 49 pieces. Each piece is worth 500 shekels, since it's 1/100th of a 50000-shekel car.

Half of the buyers buy it for the investment, a few buy in because they like the idea of part-owning a classic car, a few buy in because their friend told them to... all have different motivations just like everyone walking down the street has different motivations.

Classic cars are coming into fashion, and it's not hard to imagine that the car will be worth 100000 sheckels in five years. In fact some people think it's worth 60000 sheckels right now! Boy what a great investment that would be - you'd double your money in five years - everyone wants in on that kind of action.

But it's risky, and not everyone HAS a few shekels to invest in a piece of paper. In fact, the worth of that piece of paper is going to be different to everyone. Some will feel it's not worth anything at all. Some will feel it's a trivial amount. Everyone is going to argue on the potential worth of the car, although actual car sales reports will tell you the current value fairly accurately...

Because the car's worth and future worth is in dispute, if you now go to sell that piece of paper, you'll find that some people think it's worth 300 and some think it's worth 800. The people who think it's worth 800 will not PAY 800, though, because the sellers also disagree on the worth. Some will sell for 450, because they suddenly need shekels to pay their mortgage. Some will not sell for 900 because they believe the investment is worth 1000 in 5 years and they have put the paper into their lockbox until then. But they do know what the last sale was for, and that's a good guideline for what the next sale is worth, because other people had to get together and agree on a price.

And that's the stock market, except that instead of buying 1/100th of a classic auto, you're buying 1/100000000th of General Electric. And because the stakes are so high, GE reports on its actual finances in tremendous detail all the time, and thousands of people are devoted to trying to figure out the actual worth.

What market conditions?

The value of classic cars, the number of people who have shekels to invest in something, the number of shekels available for investment, the number of people who are inclined to buy pieces of paper for investment purposes and the number of pieces of paper offered by other classic car owners. There are so many conditions that determine the value. The actual current value is whatever someone was willing to pay.

Why does the amount of transactions affect the price?

If people are interested in trading something, there is probably news about it. Let's say news comes out that there was a discovery of a mint garage full of 1948 Toadies. The actual current value of my Toadie falls dramatically! Everyone tries to sell their piece of paper. There will still be buyers at SOME price...

Why are there different purchase prices? How do they know? Who decides the prices?

That should be clear now - everyone has a different belief about the value and future value, so the price has to be agreed upon and it changes all the time.

How can market conditions be measured that quickly and precisely?

The actual price of the piece of paper tells you exactly what someone would pay for it so at that moment there is no mystery at all. Also, enormous effort is put into calculating market conditions because there is so much to be gained or lost.

Are companies at all in control of supply and demand - is it based on annual performance or predictions?

Once the pieces of paper go out, the companies can issue more paper... but they are responsible to the owners of those pieces of paper and in public companies the paper owners get together and exect a board of directors to run the company. Of course the paper owners are interested only in making the value of their paper increase. GE has no direct control over the paper that is out there. But they want to make the value of the company increase so that the value of the paper increases.

good analogy UT - interested in a new career? story sellers are the most effective and have the happiest customers. (and generally make the most$$$$$$ along the way)

Wolf - the people with different colored coats have different functions, but most of the action you see on the floor is the process of matching up buyers and sellers. only certain people (companies) are allowed to act as clearing houses for certain stocks and all trades to go through them (excluding extremely large institutional trades). that is as much as anyone who doesn't work on the floor needs to know. that - and it is all going to computers in the near future.

Catwoman - "the little numbers..." i think someone had asked about the TICKER. you see it on the news - it scrolls by showing the trade symbol followed by the price. there are different ticker levels available, but what you have access to is generally delayed 20 minutes rather than up to the second accurate.

Is there a limit? When you've given away over 50% is it still your company?

So really, when one buys shares, one would negotiate the share price? If demand determines price, surely there wouldn't be fixed prices like you see in the stock exchange? Or is that just an average price?

and this would apply to share prices not just overall company price?


I am kind of beginning to understand it, in a still not really getting it kind of way. I understand the wider points about market conditions, supply and demand now, but the fine points about how it all happens.... :eyebrow:

Every stock sale is negotiated. If you have stock, you can tell your stock broker to sell it only at 12 shekels. But if the price never reaches 12, the sale won't happen because that means nobody was willing to pay 12. Your offer stood out there and nobody took it up.

The numbers reported are not averages, but the price of the last sale of the stock.

You don't own the company unless you have a majority of the shares, but this is where I get lost. Companies don't have to own any of their own shares. In public companies the shareholders elect the board, so majority shareholders obviously hold majority sway.

Ah. Does that include the general FTSE or NYSE figures? So lets say the FTSE closed at 443.2, 5 points up from yesterday. What does that mean?

This is where corporate structure comes into play. The principals can choose how a company will be structured - which ranges from the entire company being owned by shareholders to just a small portion (I should know if the SEC has a % public ownership requirement, but I don't). Obviously if a CEO or President owns a large chunk of a company, he has more control over matters on which shareholders must vote (in general, each share of stock, or piece of paper, gives you a right to vote).

This determines some of the long-term risk of a company. If you are aware that a CEO has made poor choices in the past and controls 40% of his company, you may decide not to invest because there's a chance he'll screw it up again.

Conversely, a large investment by the principals is likely to be a long, long, long-term investment, so there is a chance the remaining shares will trade at a premium since there are fewer available to buy/sell. If all shares are available on the market, something like a poor profit report could trigger a massive sell-off and make your pieces of paper worth as much as the paper with which you wipe your arse.

To answer your question, no, there is no limit. But existing shareholders and company directors must approve an increase in the amount of stock a company places in the open market. If ABC Co. issues more stock, obviously there is the risk that the company's value will be diluted (more shares = smaller bit of ownership). On the other hand, most companies have stock buyback programs, where they will repurchase shares from shareholders in an effort to boost the value of outstanding shares. It's a delicate balance.

Edit: to follow on UT's post, yes, corporations are stand-alone entities and owned by no one in particular. The amount of stock you or other people hold determines your level of ownership. A common thing you'll see is an investment fund trying to buy up a ton of shares so they might become a majority shareholder - which gives the fund power to sway company affairs in its favor.

Carl Icahn, who bankrupted TWA, is a well-known "corporate raider" on Wall St. His investment groups go after 10-50% stakes in companies and rally for changes they think are necessary - and the threat is legitimate because they own a boatload of the company.

My 1948 Toadie stock sells at 500 shekels, which is informative for people trading in 1948 Toadies. Let's say two other people are issuing stock for 1948 cars. The "1948 Representative" stock sells for 400 shekels, and the "1948 Celebrant" sells for 250.

You add all the prices for the 1948 cars, and average it, and you would then have a rudimentary average price for 1948 cars. That is an "index" of how much people are paying for 1948 cars.

If my Toadie's price goes up but the others go down, maybe it's just because of something to do with Toadies, and not just about 1948 vehicles in general. The index tells you better information about cars.

Similarly, with the prices of all 1940-1950 Toadies, you'd know generally what people were paying for 40's era Toadies. If the price went up you might suggest that there was a rising interest in such things.

If you indexed ALL the stock, not just for cars but for everything, you'd get one picture of the economy: how much people were investing in total, how much money wound up in the markets. The NYSE tells you how much people were investing in the NY Stock Exchange. The FTSE tells you about other markets.

I'm not sure why they report this information. The day to day change is not interesting unless it's a large leap up or down. The trend up or down is more important.

So what's the difference between Stocks (shares of the company) and Bonds and Mutual Funds?

Stocks are ... well, shares of a company.

Bonds are debt. By buying a bond, you are loaning the company a certain amount of money (however many bonds you buy). In return, the company is promising to pay back the principal at a certain interest rate at a given time. It's a mini loan, I guess you could call it.

There are also many, many different types of other debt, known as "notes." Senior, subordinated, secured, unsecured - those determine your place in the creditors' line if a company goes bust. Convertible notes give a company the right to call the debt and exchange it for common stock (swapping the debt - a liability - to boost equity, in accounting terms).

Mutual funds are exactly what the name suggests: You buy into a cooperative fund and some schmuck decides how to invest that money for you. It's considered a good way to invest since the risk is spread across a wide variety of stocks and bonds, but you have to be careful about how fund managers allocate the money.

I would explain that whole mutual fund scandal from two years ago, but, not now. Maybe a little later.

So bonds would be a safe investment, because it's for a specified term, and they earn interest, like a savings account?

I forgot to explain how bonds are classified, high yield (junk), low yield etc., but now it's busy at work and no time.

Safe investment, but very limited returns and possibility of bankruptcy, in which case you might get squat.

sorry if some of the posts don't make sense - i had to delete a couple of my posts as i received a notice today that regulators are trolling bulletin boards and will now hold firms responsible for anything that a broker says in a bulletin board.

No one knows who you work for or even who you are. So what if a regulator sees someone offering to anonymously explain the stock market.

Besides, if any regulator sets foot in here, LJ and I will take care of him for you :)

stupid paranoia on my part i'm sure, but it is amazing what can happen when a regulator gets a woody for something.

i really can't give investment directions or suggestions to someone in a state that i am not licensed in. even more tricky is that this is an environment where i cannot reasonably control who would follow my directions... it sounds stupid, but i'm just playing CYA.

Frankly, I don't blame you for your discretion.

I think there is probably enough information in terms of the basic nuts and bolts of the operation of the market that you could provide us without problems.

I've often been curious, but never curious enough to get the "For Dummies" guide.

if enough people were actually serious and wanted real info, i can license myself any place i want in about 2 days, but if there isn't a reason too, then why spend the $$$.

*except NY - EFF NY! they know that there is a high concentration of 7 licenses in NY so they charge an exorbitant fee there - a fee that i will not pay on principle.

i'll still answer any questions i can here, i just need to be more careful when pressing the submit button.

and if you come across any old threads where i've identified myself or my firm (i know i did, but i can't remember where)- please send me a note so i can get rid of that?

Could we go back a bit please, because I still don't understand how there's always a buyer for a stock being sold, even if it's in a desperate tailspin heading for delisting ...

you know the addage about a sucker being born every minute? there is always someone who thinks that ABC is a bargain.

but at some point the market does dry up. I have had instances where there was "no market" for my client's shares. it happens quite a bit when someone buys penny stocks - they tend to go bad and no one wants to buy. in that case, the holder of those shares gets to just keep hanging on to them. it is sort of like real estate - it is only worth something if someone wants to buy it.

for the most part though, there is always an open order to buy of ABC and an open order to sell of ABC. The "market maker's" (the people in the colored coats) are there to match the two up and charge a fee along the way.

Hey, dude, happy cellar one year and 20 day anniversay ... (I just noticed).

There's always a buyer for major market stocks, though, because there are hundreds of people that only buy and sell on the basis of trying to figure out where the right price actually is. And most stocks are not playing Enron-style games with their markets, because they can't. Even if IBM doesn't sell a single computer, their intellectual property, their people, their customer base etc is worth a great deal.

thanks wolf - if i'm only one, why does my body ache this way?

UT - yu are correct.

High mileage, lookout my boy, high mileage.

Price also gets corrected because people are looking at what the company and the stock will be worth in *different future points in time*. There are always investors who are looking to get results in a day, a month, a year, 2 years, 10 years, 30 years.

When Martha Stewart was in her worst trouble, the price went to like 20, but because her short-term prospects were horrible, her long-term prospects were not; and when she got out and it looked like her reknown would be greater than ever, the stock went back up to 40. If you were playing the long term, and really amazingly prescient, you might have figured that out when things looked to be at their worst.

In fact I've heard some people have systems where they buy stock that appears to be at its very worst point. Figuring out which ones are Martha Stewarts (where you double your money in 6 months), and which ones are Enrons (where you lose it all), is beyond me, but there are people who do it.

I bought Teligent at $35.00±/share once. It rose to $50. Then Bill Gates pumped $500M into the company. It rose to $100. I had to buy new shirts to accomodate my new chest size :).

Then, it fell. and fell. and fell. and fell. Then, it started falling. -snip- on Dec 31st of that year, I sold it all. For six cents per share. I sold it on the last day of the year so I would at least be able to write off the loss on my taxes. But, someone actually bought it at $.06/share. Who knows, maybe somebody found a hidden stash of paper clips behind a file cabinet which pushed it up to $.07/share. That's a 16% profit!

I mention this for two reasons. To illustrate that there is usually a buyer at any price. Hey, if someone bought ALL the shares at six cents, they would own ALL the assets of the company (following up on UT's observation). Well, maybe all Teligent's equipment, cars, computers, desks, chairs, a box of unopened golden handcuffs, etc. are worth more than ($.06)*(total number of shares).

The second reason I mention it is because I grow weary of hearing one after the other story (not here but IRL) of how Bob bought X and it tripled in 3 days, and Frank bought Y and it shot through the roof. No Body talks about how they bought a stock that later went on to rival a black hole from Stephen Hawking's worst nightmare for suckitude.

When my former employer tanked, it was estimated by the court trustee that we had about 25 mil in assets and 100 mil in debt (including the two paychecks that every American employee didn't get and the pension fund money that they literally stole out of the accounts of the UK employees... grumble grumble.) The stock had been trading at around 75 cents prior to the bankruptcy announcement. Afterwards, it was delisted, but somehow still managed to continue trading at a half-cent to 1-cent. This caused a lot of problems for employees who had been part of the Employee Stock Purchase Plan, because they couldn't write it off as "worthless" for tax purposes because it clearly still had a miniscule worth, yet they couldn't get any of their brokers to bother with the transaction of actually selling those shares.

I think in the end most of them just pretended that it WAS worth zero and wrote it off as such. Could that be counted against those employees in an IRS audit? And how is it that a bankrupt company, now essentially "owned" by the court as they will be determining to whom all the existing assets will be given, can still have "shares" at all??

A share is a claim on the assets of the company. Debt is also a claim on the company. Debt always comes before equity so all assets will be liquidated and distributed to the debt holders and since there isn't enough to satisfy their claims, all ownership claims (e.g., outstanding stock) will be terminated/voided.

I'm sure there is a real rule about how to treat an untradeable stock but, in time, it really will be worthless. It may be possible to "surrender" one's claim/"abandon" the claim to make it official - so you wouldn't have to wait ten years for a court to stamp it worthless. Its worth looking into.

that is textbook "value" philosophy investing, versus "growth" investing. the two philosophies take turns leading the way with the best returns. value has been doing better than growth for a number of years.

Clodfobble - i am not an accountant so i can't tell you about audits.

i can tell you that if there is "no market" a "no market" letter can be used as proof that the stock is a loss.

In order to increase liquidity, the NYSE also has what are called specialist firms. Their job is to buy equities when no one else is available. During the 1987 stock market crash, these specialist firms bought massive amounts of stocks when no one was buying. The Federal Government even setup emergency loans to these specialists so they could buy those stocks. Loans that helps maintain the integrity of the market. As a result, those specialists later sold stocks mostly at a profit.

Specialist firms were mostly family owned organizations. But since then, most (if not all) specialist firms have been bought up by large equity firms. Listen closely to the news. Those specialist firms are now under investigation for trading activities. Back then, the purpose of a specialist firm was to serve the market. Today, profits have become more important meaning that some specialist firms are under SEC or NY state investigation. Back then, the good name of that family was at stake. Today ....

Stock markets are carefully to keep stocks liquid. A stock market will do everything possible to assure an equity can be sold. Stocks that trade too thinly can even be delisted from that exchange. All this so that a market always exists for your equity. The liquidity of your stock is very important to those who own and operate stock markets.

Is this the same company that was originally established in a joint venture of IBM and Apple Computer?

No, it was started by Alex Mandl from AT&T and some SVP from MCI as a telecom. Neither IBM nor Apple were involved in it.