How does the share market work?
The stock exchange exists so owners of shares in companies can buy and sell with other buyers and sell. Companies who are listed on the stock market issue a number of shares for investors to purchase and the price of the stock rises and falls as demand for the shares fluctuate. When you buy a share you essentially own a small portion of that company and if that company turns a profit and decides to issue what is called a dividend as a shareholder you will receive a portion of the company’s profit depending on how many shares you own.
Companies listed on the stock market are called publicly listed and when you buy and sell your shares you are buying and selling them from other investors and not the company itself.
What is a dividend?
A dividend is a payment made to investors by a company whose shares they own. A dividend is a portion of the company’s profits and is paid to the shareholders at the discretion of the board of directors and shareholders who have voting rights.
What does market capitalisation mean?
Market capitalisation is simply the total numbers of shares issued for the company listed on the stock market, times the value of the current price. For example, in September 2019 the number of shares issued by Apple was 4,443,236,000. The share price in September 2019 was approximately $200. Therefore, the market capitalization of Apple was $200 times 4,443,236,000. A sizeable sum.
What is a stock exchange?
A stock exchange exists to allow companies to issue shares for investors to buy and sell on a daily basis. It also acts as the regulator and facilitator for the buying and selling of the shares. For every buyer there must be a seller therefore if there are more buyers than sellers the price of the share rises in value and if there is more demand to sell the shares of a company the price falls in value.
What is an investment bank?
An investment bank such as Goldman Sachs, JP Morgan & Deutsche Bank specialise in financial transactions that many traditional retail banks do not accommodate. Such as Initial Public Offerings where a company wants to list on the stock market, major corporate mergers and acquisitions are also facilitated by investment banks. Some have retail operations however many do not preferring to focus on large corporate transactions where they can handsomely profit from charging fees for service.
Investment banks will often have their own trading desk where they have a team of traders trading the banks money in the financial markets to increase the banks profit. Investment banks can also act as liquidity providers for the foreign exchange market as well as making prices and products for companies and investors to trade.
What does Bid and Ask mean?
Due to the fact there are always buyers and sellers in financial markets the market acts like an auction creating what is called a bid ask or bid offer spread. There is always a bid price, the price at which someone is willing to bid to buy the stock or currency and there is always an ask price which is the price at which the seller is willing to sell. A trade occurs when the buyer accepts the ask price or the seller accepts the bid price. The same as a house auction. If the buyers outnumber the sellers the price rises very quickly and if the sellers outnumber the buys the price falls very quickly.
What is a CFD?
CFD stands for Contracts For Difference and allow investors to speculate on the price direction of a stock without having to own the stock. Instead of buying shares in the company investors are simply speculating on the price movement and whether or not it will rise or fall in value. A broker will quote the price of the company’s share price and by buying a CFD you are entering into a contract with the broker speculating as to whether or not the share price will rise or fall.
Let’s assume company XYZ’s share price is $45 and you wanted to purchase 100 shares. Normally you would need $4500 to buy the 100 shares in XYZ however if you speculate on company XYZ using CFD’s you do not have to have $4500 and will only be required to have a fraction of this money in your account.
A CFD broker may only require you to have 10% of the value of $4500 to speculate on the future price of XYZ, meaning you would only need to have $450 to control a position of $4500. Brokers offer various levels of leverage when you trade CFD’s and whilst they can be a very low-cost way of speculating in the stock market investors who do not manage the leverage being offered can lose large amounts of money when the share price moves against them.
What is a portfolio?
The most common reference to a portfolio is a stock portfolio which is a group of stocks that you may have purchased. A portfolio can be any number of stocks and is not limited to the stock market. A portfolio may include bonds, currencies, stocks, property, ETF’s, commodities and even cash. Investors often like to have a portfolio of assets to ensure they are not overly exposed in one market segment. Think of it like a cake that is divided up into slices which in the case of a portfolio may reference different shares or different asset classes as listed above.
What is a fractional share?
Fractional shares are often used as a way for investors who cannot afford to buy larger amounts of the stock to buy fractional shares. Fractional shares are exactly what the name suggests, fractions of shares and when you cannot afford to buy larger quantities of a stock because of its high price you can still buy a fraction of a share and profit if the share price rises. If the stock is subject to a dividend distribution your dividend will be equal to your fraction of the shares you own.
What is a hedge fund?
A hedge fund is a fancy name for a managed fund. It operates in a similar fashion pooling investors’ money together which is then invested in the financial markets in the hope of an above average return. Hedge Funds can deliver higher returns but the downside risk is also apparent. A hedge fund will often have a large minimum investment criteria and may take bets in riskier markets with less regulation than traditional managed funds.
Hedge Funds will often charge performance fees of between 20% and 30% which are far higher than a traditional managed fund.
What is the S&P 500?
The S&P 500 Index is a list of the 500 largest companies listed on US stock market by market capitalization. It is often regarded as a guide to how US company earnings and revenues are performing. S&P stands for Standard and Poor’s who is a rating agency.
What is the Dow Jones?
The Dow Jones Index is a list of the 30 largest companies listed on US stock market by market capitalization. It is technically called the Dow Jones Industrial Index and was first started in 1896 by Charles Dow and Edward Jones who would measure the value of the top 30 stocks listed on the New York Stock Exchange and the information would be printed in the Wall Street Journal.
The market capitalisation of the top 30 companies listed in the Dow Jones at the end of 2019 was over $6.6 trillion US Dollars.
How to open a broking account?
Most brokers offer an online web form that you can fill out to open your account. You will be required to provided ID and you will also be asked which type of account you wish to open. For example, do you wish to open the account in your personal name, a company, a self-managed super fund or other. Once your online application has been processed and the account is open the broker will contact you with funding instructions.
It is a good idea that before you fund your account that you familiarise yourself with the demo trading platform provided by the broker so you can practise entering and exiting trades before trading real money.
What is the Nasdaq?
NASDAQ stands for National Association of Securities Dealers and is a stock exchange based in New York. There are more than 3000 stocks listed on the NASDAQ which began in 1971 and was started to speed up the buying and selling of shares via a computerised system. The NASDAQ is also home to many of the world’s leading technology companies such as Apple, Microsoft, Google and Amazon.
How do brokers work?
A broker is an individual or company that facilitates your orders in and out of the financial markets and charges a fee for service. A broker in the financial markets should be licensed with the relevant securities agency and will generally provide a computer-based execution platform for customers to place their buy and sell orders through. Full-service brokers are a dying breed as retail traders today have quicker, cheaper and more effective access to financial markets via electronic trading platforms rather than calling the broker and confirming the trade over the phone.
A broker will generally ask you to open your account via an online form and once the account is open you will be invited to fund your account via a bank account number provided to you by the broker. Funds should be separated from other clients and unless you sign a power of attorney document allowing someone else to place trades on your behalf the only person that can place buy and sell orders is you. The broker acts as a middle man between the buyer and seller. Just like a real estate broker acts as a middle man between the buyer and seller of a house and charges a fee for service. Financial market brokers are the same.
What is a buy stop order?
A buy stop order is a pending buy order where a trader nominates a price that is higher than the current market price. For example, if the AUD v USD is trading at 0.6772 and a trader would like to buy the AUD v USD at 0.6800, they would place a pending buy stop order at 0.6800 and the price would have to rise higher to their entry price before they would be filled into the trade.
What is a market order?
A market order is when a trader is willing to accept whatever Ask price is being offered right now. For example, if a trader is looking to buy shares in XYZ company and the Ask Price is 1.45 the buyer is willing to accept 1.45 and places the trade. Similarly, if a trader is taking a short position they are willing to accept the bid price.
What is a buy limit order?
A buy limit order is when a trader places a pending order that is lower than the current market price. For example, if the stock BHP is currently trading at the price of $30.05 and the trader would like to buy BHP shares at $29.35, they would place a buy limit order at $29.35 and the price would have to fall to their entry price before being filled on the trade.
What is a sell stop order?
A sell stop order is a pending order where a trader nominates a price lower than the current market price. For example, if the EUR v USD is trading at 1.0934 and a trader would like to take a short position on the EUR v USD at 1.0900, they would place a pending sell stop order at 1.0900 and the price would have to fall to their entry price before they would be filled into the trade.
What is a sell limit order?
A sell limit order is when a trader places a pending order that is higher than the current market price and they are looking to take advantage of a potential fall in the value of the asset they are trading. For example, if the AUD v USD is currently trading at the price of 0.6785 and the trader would like to take a short position at 0.6800, they would place a sell limit order at 0.6800 and the price would have to rise to their entry price before being filled on the trade.
What is a stop loss?
A stop loss is a nominated price a trader wishes to exit their trade. It is highly recommended you use a stop loss on every trade you take to limit downside risk.
What is a risk calculator?
A risk calculator is a tool that is used to calculate a fixed dollar risk or a fixed percentage risk on a trade position before it is executed. A risk calculator is only a general guide and cannot take into consideration gaps or slippage that may occur on a position. For example, if the size of the account is $5000 and the trader wishes to place a trade using a risk of 3% the risk calculator will work out what volume of money should be executed based on the market being traded and stop loss size nominated.
What is leverage?
Leverage is the use of borrowed funds in the aim of increasing the potential return on a trade. By using leverage, you increase your buying power however you also increase your risk. You will be required to put up what is called a margin requirement that is a deposit of money the broker will hold until the trade is complete. Following is an example of leverage.
A trader may wish to buy 100 shares of company XYZ that is trading at a price of $50. Ordinarily the trader would need to have $5000 to place the trade however CFD brokers may offer the opportunity whereby with just $50 you can have 100 to 1 leverage and control the $5000 worth of shares. The amount of money you are required to have in your account to place a trade using leverage is often referred to as margin.
What is margin trading?
Margin is the money that is borrowed by a trader from the broker to buy shares or a financial asset. Interest is charged on the borrowed funds and it must be considered that whilst margin trading does allow a trader to control a larger number of shares with a smaller amount of money a small fluctuation in the share price increases the downside risk for the trader.
What is slippage?
Slippage is when a trader places a pending order and the price they are executed is different to what they nominated. Slippage may occur is fast moving markets when the bid and ask changes quickly and there are more buyers and sellers entering the market. Slippage often occurs when volatility increases and large orders are placed. If a large order is placed and a trader has a nominated pending order at a price the large order may create a situation whereby the bid and ask spread is varied and the price slips to the next available price.
For example, if a trader placed a buy market order to buy a stock and he or she wanted to buy 1250 shares, if only 500 shares were available at the current market Ask Price, the first 500 shares will be filled and then price would move to the next available higher Ask Price until the 1250 shares are filled. Therefore, the price may slip up from the original market price to execute all the volume the trader is wanting to buy.
What is a bond?
Bonds are usually sold by governments and companies looking raise money and investors buy bonds to earn a fixed income. For example, an investor may buy $100,000 worth of US Government bonds and earn a fixed income of 1.3% per annum for 10 years. At the end of the 10-year period the initial $100,000 is repaid to the investor. Bonds may vary in length from months to 100 years.
Bonds are often used by governments and companies to pay for infrastructure projects, refinancing of debt, capital expenditure and many other reasons. It is generally considered a low-cost way for a government to borrow money. In the case of a government they will issue a bond that will include the terms which will be the interest paid and the time when the loan must be paid back to the investor which is called the maturity date. The interest paid is called the coupon rate.
What is a Bond yield?
A bond yield is the interest an investor earns on the money they have lent through the purchase of bonds. It is similar to a dividend a shareholder receives when buying shares in a company that pays annual dividends.
What is a futures contract?
A futures contract is often used by investors to speculate on the future price of an asset. Futures contracts may require the buyer to purchase whatever underlying asset they have purchased at a predetermined price and date in the future. Many traders use futures contracts to simply speculate on the future price of a commodity or derivative and do not enter the contract with any intention of having to physically deliver the product, and sell before the futures contract expires.
What is an ETF?
An ETF is simply an investment fund, for example a group of stocks traded on the stock exchange much like an individual stock. For example, instead of buy all 30 stocks in the Dow Jones Index you can simply buy an ETF of the Dow Jones and you would be buying one item. ETF stands for Exchange Traded Fund.
Most ETF’s aim to track the index of whatever assets are listed in the ETF. For example, an S&P 500 ETF aims to track the overall performance of the S&P 500 stock index and allows investors to get exposure to the entire 500 stocks by only buying one item, the S&P 500 ETF.
ETF’s are generally considered low fee investments and depending on where you live can also be tax effective.
What is a cryptocurrency?
A cryptocurrency is a 100% digital currency, not backed by anything physical. The cryptocurrency market is a purely speculative market driven higher and lower by speculators who may or may not believe the cryptocurrency they are trading will be worth more or less in the future. Cryptocurrencies are distributed across a series of computers and uses what is called block chain technology which is supposed to ensure the integrity of the digital currency and transactions.
How does the currency market work?
The currency market is often referred to as FX, Forex or Foreign Exchange and is a market in which investors buy and sell currencies against one another. Participants who trade the currency market are private retail traders, central banks investment banks, hedge funds, large companies, governments and speculators from around the world.
The currency market unlike the stock market does not have an official exchange and the prices are determined by the transactions exchanged over a global network of computers that trade through investment banks and FX brokers. The currency market transacts over $5 Trillion dollars per day making it the largest and most actively traded market in the world.
Businesses transact in the foreign exchange market as they buy and sell products from around the world. Many corporations transact in the currency market to hedge exposure when placing orders with suppliers in other countries. Speculators trade the currency market with the expectation of accurately predicting the future price direction of a currency and profiting.
When you trade a currency, you must choose a base currency and a cross currency. As an example, if you think the Euro currency will rise in value you must choose an opposing currency that you believe will fall in value. For example, the Euro v Japanese Yen.
Traders often speculate on the potential future fall in the value of a currency and taking such a trade is called taking a “short position.”
Monetary Policy and Interest rates set by Central Banks have the biggest influence on the price direction of a currency.
What is an exchange rate?
An exchange rate is the value of a countries currency versus the currency of another country. For example, $1.00 Australian Dollar as of 20th February 2020 will buy 0.6634 US Dollars. In July 2011 the same $1.00 Australian Dollar would have bought $1.10 US Dollars.
What is a currency pair?
A currency pair is the price of two currencies that trade against one another. One currency is being quoted against the other currency such as the Euro vs US Dollar. When you look at a currency pair the first currency quoted is called the base currency and the second currency is called the cross currency.
It is not possible to trade one base currency on its own and you must trade one base currency against a cross currency. For example, the Australian Dollar vs the New Zealand Dollar on the 20th February 2020 was being quoted as one Australian Dollar will buy 1.0435 New Zealand Dollars.
What does long and short mean?
Going “long” is a term used by traders when buying into a market and they are wanting price to rise. For example, a trader may say, “I have just gone long on the Euro.” This means the trader has bought the Euro against another currency and is looking for price to rise to gain a profit. Going “short” is a term used by traders who are entering a trade and looking for price to fall in value to profit. For example, a trader may say, “I am about to take a short trade on the Aussie Dollar.” This means they are about to enter a trade and will profit if the Australian Dollar falls in value.
At Trading Mastery, we do not take short positions in the stock market.
How can I make money when something falls in value?
Most people are very familiar with buying an asset in the hope of it rising and value and realising a profit when they sell it. However how can you make money if you think something is about to fall in value? Let me give you an example.
Let’s assume you grow apples for a living and this season you know there is likely going to be an oversupply of apples coming to the market and the price for a large 100Kg bag of apples is likely going to be cheaper in 1 week than they are today. For this example, let’s assume a 100kg bag of apples is $100 at the market today. If you believe apples will be cheaper in a week’s time you could ask to borrow a bag of apples and quickly sell that bag of apples to somebody for $100. You have a commitment to give back a bag of apples to the person you borrowed them from but for now you have $100 in your pocket. If you are correct and the price of apples falls in the next week you have an opportunity to profit. Let’s assume you are correct and the price of apples falls to $60 due to the oversupply you expected. You quickly go back to the market with you $100 and buy a bag for $60. You give back a bag of apples to the person you borrow them from and you have made a profit of $40.
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