MAKE MONEY THROUGH THE STOCK MARKET

Trading in shares can be a good way to make a return on your money, but it can be less rewarding if dealing costs are through the roof – these alone can snack a sizable chunk off your investment returns.

What is the 'Stock Market'

The stock market is the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets. Also known as the equity market, the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors a slice of ownership in the company. The stock market makes it possible to grow small initial sums of money into large ones, and to become wealthy without taking the risk of starting a business or making the sacrifices that often accompany a high-paying career.

Shares in a nutshell.

What actually are shares? Would they be a sound investment for a nest egg? Do they carry much risk? ls it easy to get started? Should you rely on a financial adviser or fund manager? What are bulls and bears? What guidelines should be used for buying and selling? All these questions, and many more, are answered in Shares in a Nutshell, 2nd Edition.
Buying shares is no longer the prerogative of the wealthy. In fact it's never been easier – or cheaper – to invest in the Australian stock market: it can cost less than $1,000 to buy a parcel of shares. Alternatively, a similar amount can be spread over a range of assets through an investment company or a managed fund. And even when the economic outlook is bleak, a well-prepared investor can still make a profit with shares. Shares in a Nutshell 2nd Edition has been written for people who are trying to decide if they should get involved in the market, and for those who have just bought shares and would like to learn more about them.

A share is simply a divided-up unit of the value of a company. For example, if a company is worth £100 million, and there are 50 million shares, then each share is worth £2 (usually listed as 200p). Those shares can and do go up and down in value for various reasons.

Companies issue shares to raise money and investors (that’s you) buy shares in businesses because they believe the company will do well and they want to ‘share’ in its success.

There are two options when buying shares, you can either:

1. Own shares yourself; or

2. Pool your money with other people in a collective investment known as a fund

For first-time investors pooling your money is a slightly safer option as you're not putting all your eggs in one basket (as you're not just investing in one company) and it means you can ride out any bumps in the market.

BUYING AND SELLING OF SECURITIES

Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You've probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically

The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer. Really, a stock market is nothing more than a super-sophisticated farmers' market linking buyers and sellers.

Before we go on, we should distinguish between the primary market and the secondary market. The primary market is where securities are created (by means of an IPO) while, in the secondary market, investors trade previously-issued securities without the involvement of the issuing-companies. The secondary market is what people are referring to when they talk about the stock market. It is important to understand that the trading of a company's stock does not directly involve that company.

4 WAYS TO BUY AND SELL SECURITIES

Buying and selling of securites can be done in the following ways

through brokerages,
directly from the company that issues them,
through banks and
through individual investors.

Brokerage Houses
One of the most common, and easiest, ways of buying and selling stocks, mutual funds and bonds is through a brokerage house. These companies typically require you to open an account with them, and deposit funds as an act of good faith. Brokerages are popular because they, rather than you, do much of the behind-the-scenes work, allowing you to focus on when and what to buy or sell. They look after things like completing the paperwork involved in transferring the ownership of stock, and ensuring dividend payments. (Choosing the right broker is an important first step for new investors. Find out what to look for in Picking Your First Broker.)

Brokers are classified into two different classes. Here we discuss the differences in the ways in which these two classes of brokerages transact orders.

Full-Service Broker
In the past, this was the main method for investors to enter into the securities market. Investors would simply contact their full-service brokers, and have them purchase different stocks and bonds. These transactions are quite straightforward, and full-service brokers will typically call their clients and provide recommendations for buying or selling particular securities.

Today, these brokers are not quite as popular, but with so many different investment products available, almost all full-service brokers are able to transact stocks, bonds and mutual funds. (To learn more about what this type of broker has to offer, read Full-Service Brokerage Or DIY?)

Discount Broker
Discount brokerages have become increasingly popular with investors thanks to their ever-decreasing commission fees. These brokerages, like large supermarkets, provide investors with almost everything they need at a low cost. However, this also means that investors have to do most of the work themselves. At almost all discount brokerages, you can buy stocks, bonds or mutual funds either by calling one of the investment representatives, or by transacting these securities yourself on the internet.

The commission for calling in to a discount broker will cost more than completing the transaction online, but the motions are all pretty much the same. First, you have to enter an order ticket. Don't be intimidated - the order ticket merely states the type of security you want to purchase (whether it's a bond, stock or mutual fund), the price you want to buy it for, the quantity you would like to buy and the duration for which you want to leave the order valid (e.g., one day to one month). The order ticket must be completed, whether by yourself, on your computer, or by your broker, while getting your instructions over the telephone. After everything is filled out completely and correctly, the order is sent to the exchange, where the stock, bond or mutual fund is bought or sold at whatever terms are on the order ticket.

Directly from the Business

More often than not, the method of transacting directly with the issuing company is more difficult than buying and selling securities through the broker; albeit transacting directly does have advantages.

When evaluating this transaction method, there are a few unique considerations. First, are you comfortable with holding the securities yourself? When you buy stocks and bonds directly from the issuer, they will be held in certificates, either in bearer form or registered form, which means you are responsible for the safekeeping of the security. If you lose a security in bearer form, there is no way to retrieve it - the person who finds it is the proud new owner of your stock. If you lose a security in registered form you must, to be issued a new certificate, undertake the process of contacting the issuing company. This problem or concern, however, doesn't arise with mutual funds because you don't actually hold units individually.

Second, do you need access to the funds immediately? When you are selling mutual funds, you usually have to wait three days after the transaction date before you can receive any cash. This is irrespective of whether you bought into the fund with a brokerage or with the actual issuing firm. The wait for stocks and bonds, however, can be significantly longer. If you want to sell instruments that are in registered form, you have to sign the back of each certificate, and then send them to the issuing company before you can receive any cash. Obviously there's always some concern about whether the certificates will get there in a timely and complete manner.

Third, how important is the price of purchase or sale to you? If you are a penny pincher and like to buy stocks, bonds and mutual funds for the cheapest possible market price, dealing directly with the business may not be suitable for you. Freedom to choose a transacting price becomes limited when you buy directly from the company. When you buy stocks and bonds directly from an issuer, you will typically have to buy them at a price set by the issuer and sell them back at another set price.

After taking the above into account, here are some advantages to buying and selling direct. Businesses typically have few restrictions on the minimum number of units being purchased. Some brokerages require minimum initial mutual fund purchases of $1,000, whereas if you buy directly from the issuer, the minimum can go down to $500 or less. Additionally, you don't need to have an account, which sometimes require a minimum balance and penalizes long-term investors with inactivity fees.

Banks

Although most banks don't sell stocks, they do offer mutual funds and bonds, but their selection will be limited to funds offered by the bank itself, or through its partners. Banks also provide for a convenient location to buy bonds and mutual funds: you can simply walk to just about any corner bank and purchase these investments on the spot.

When you do go into a bank, the representative helping you should be able to tell you the different characteristics and minimum purchase amounts of the products that are available for purchase.

Person to Person

Theoretically, you can buy and sell securities individually (outside of an exchange). Suppose that a friend of yours has a stock that you would like to buy, or a relative who needs the funds immediately would like to sell you a bond; it can be done. But, this method of transacting securities poses a significant risk; you must trust the person with whom you are dealing with, and make sure you are not being scammed - for instance, you could be sold a false, laser-copied certificate.

If you are decided upon doing this type of transaction, you will, for most stocks and bonds, only have to sign the back of the certificates, and then they can be sold to another party. If you are trying to buy them, the other party will have to sign them over to you. After the security certificates are signed, they must then be sent back to the company to be reregistered under the name of the new owner.

Conclusion
There are many ways to buy and sell securities, but they all provide different advantages, difficulties and risks. Whether you decide to deal with a full-service or discount broker, issuing company, bank, friend or a relative, there are many options out there. Just make sure that you've done your homework to find out which route is best for you.

RISK OF HOLDING SHARE IN ONLY ONE COMPANY

Risk is absolutely fundamental to investing; no discussion of returns or performance is meaningful without at least some mention of the risk involved. The trouble for new investors, though, is figuring out just where risk really lies and what the differences are between low risk and high risk.

What Is Risk?
Given how fundamental risk is to investments, many new investors assume that it is a well-defined and quantifiable idea. Unfortunately, it is not. Bizarre as it may sound, there is still no real agreement on what "risk" means or how it should be measured.

Academics have often tried to use volatility as a proxy for risk. To a certain extent, this makes perfect sense. Volatility is a measure of how much a given number can vary over time and the wider the range of possibilities, the more likely some of those possibilities will be bad. Better yet, volatility is relatively easy to measure.

Unfortunately, volatility is flawed as a measure of risk. While it is true that a more volatile stock or bond exposes the owner to a wider range of possible outcomes, it doesn't necessarily impact the likelihood of those outcomes. In many respects, volatility is more like the turbulence a passenger experiences on an airplane – unpleasant, perhaps, but not really bearing much relationship to the likelihood of a crash.

A better way to think of risk is as the possibility or probability of an asset experiencing a permanent loss of value or below-expectation performance. If an investor buys an asset expecting a 10% return, the likelihood that the return will be below 10% is the risk of that investment. What this also means is that underperformance relative to an index is not necessarily risk - if an investor buys an asset with the expectation that it will return 7% and it returns 8%, the fact that the S&P 500 returned 10% is largely irrelevant.

Think about it. If that company gets into difficulty then you could lose some or all of your money. Instead, spread your risk by buying shares in a variety of companies.

It's also tempting to try to time the market, but it's almost impossible and even the most experienced investors get it wrong. By pulling out of the market as soon as a share dips or trying to second-guess when a share will reach its peak, you could lose out on sharp recoveries or see the price go down again.

Instead, you should invest on a regular basis – in investment lingo this is called 'drip-feeding' – to smooth out any ups and downs. This will give you an added benefit of something called 'pound cost averaging'.

This is how it works:

If you invested a £10,000 lump sum and bought shares valued at £10 each, you'd have 1,000 shares. If you bought £5,000 worth of the same shares per month over two months (amounting to £10,000 overall), you'd buy 500 shares in the first month.

But if the share price went down to £9.50 in the second month, you'd be able to buy 526 shares, as the shares are at a lower price. So, rather than just getting 1,000 shares for your £10,000, two payments of £5,000 buys you 1,026 shares.