Your stock market questions answered

[lookout123]

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.

[lookout123]

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.

[smoothmoniker]

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

[lookout123]

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.

[Clodfobble]

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?

[lookout123]

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

[wolf]

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?

[Catwoman]

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.

[Undertoad]

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.

[lookout123]

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.

[Catwoman]

Originally Posted by UT

Once the pieces of paper go out, the companies can issue more paper

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

Originally Posted by UT

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.

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?

Originally Posted by UT

The actual current value is whatever someone was willing to pay

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....

[Undertoad]

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.

[Catwoman]

Originally Posted by Undertoad

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

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?

[breakingnews]

Originally Posted by Catwoman

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

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.

[Undertoad]

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.