stocks and efficient markets
Investors can purchase stock through stockbrokers on exchanges, through mutual funds, or through 401K plans.
Equities, or shares of a common stocks that represent ownership of corporations, form another type of financial asset that is available to investors.
Share Values
Stock Market Efficiency
Mutual Funds
401K Plans
Equities, or shares of a common stocks that represent ownership of corporations, form another type of financial asset that is available to investors.
Share Values
- There are different ways to buy equities.
- An investor may want to use a stockbroker - a person who buys or sells equities for clients.
- The investor can also open an internet account with a discount brokerage firm.
- This allows the investor to buy, sell, and monitor his or her stock portfolio from a personal computer.
- The value of a single share of stock depends on several things.
- Both the number of outstanding shares to be traded and a company's profitability influence the price.
- Expectations are especially important, because demand for a company's stock increases when the prospects for its growth improve.
- Common to almost all stocks is that their value goes up and down daily, sometimes gaining or losing a few cents a share and at other times gaining or losing much more.
- This is due to change in either the supply or the demand for a share of stock.
Stock Market Efficiency
- Most large equity markets are reasonably competitive, especially if they have a large number of buyers and sellers.
- When these conditions exist, stocks can be easily bought and sold, so any news that affects the supply or demand for stocks can affect stock prices on a daily basis.
- There is no sure way to invest in stocks in order to always make a profit.
- Stock prices can vary considerably from one company to the next, and the price of any stock can change dramatically from one day to the next.
- Because of this variability, investors are always looking at stocks to find the best ones to buy or sell and those to avoid.
- All of this attention makes the market more competitive.
- Many stock market experts subscribe to a theory called the Efficient Market Hypothesis (EMH) - the argument that stocks are usually priced correctly and that bargains are hard to find because stocks are followed closely by so many investors.
- The theory states that each stock is constantly analyzed by many different professional analysts in a large number of stock investment companies.
- if the analysts observe anything that might affect the fortunes of the companies they watch, they buy or sell the stocks immediately.
- This in turn causes stock prices to adjust almost immediately to new market information.
Mutual Funds
- Because of the advantages of diversification, many investors
401K Plans
- Portfolio diversification and the need for
stock markets and their performance
Several different stock markets exist, and each is organized in a different way.
Stock Exchanges
Bull vs. Bear Markets
Stock Exchanges
- Historically, investors would gather at an organized stock or securities exchange, a place where buyers and sellers meet to trade stocks.
- An organized exchange gets its name from the way it conducts business.
- Members pay a fee to join, and trades can only take place on the floor of the exchange.
- The oldest, largest, and more prestigious of the organized stock exchanges in the United States is the New York Stock Exchange (NYSE), located on Wall Street in New York City.
- The NYSE lists stocks from about 2,700 companies.
- They also must meet profitability and size requirements, which virtually guarantees that they are among the largest and most profitable publicly held companies.
- Another stock exchange is the American Stock Exchange (AMEX), which is also located in New York City.
- It features companies that are smaller and more speculative than those listed on the NYSE.
- Many regional exchanges are located in other cities such as Chicago, Philadelphia, and Memphis.
- They list corporations that are either too small or too new to be listed on the NYSE or the AMEX.
- Organized stock exchanges are found in major cities all over the world, including developing countries such as Ghana, Pakistan, and China.
- Developments in computer technology and electronic trading have linked the biggest markets.
- This means that today you can trade in most major stocks around the clock, somewhere in the world.
- Despite the importance of the organized exchanges, the majority of stocks in the United States are not traded on these exchanges.
- Instead they are traded in an Over-The-Counter Market (OTC) - an electronic marketplace for securities that are not traded on an organized exchange such as the NYSE>
- The most important OTC market is the National Association of Securities Dealers Automated Quotation (NASDAQ), the world's largest electronic stock market.
- Rather than being limited to a single trading location, NASDAQ trading is executed with a sophisticated telecommunications and computer network that connects investors in more than 80 countries.
- The total number of stocks listed on the NASDAQ exceeds the combined total of the NYSE and AMEX.
- The organized exchanges and the OTC markets may differ, but this means little to individual investors.
- An investor who opens an internet account with a brokerage firm may buy and sell stocks in both markets.
- When the investor places an order to buy shares, the broker forwards the order to the exchange where the stock is traded - whether it is on the NYSE, AMEX, or NASDAQ - and the purchase is made there.
- Because they are concerned about the performance of their stocks, most investors consult one or two popular indicators.
- When these indicators go up, stocks in general also go up.
- The first of these indicators is the Dow Jones Industrial Average (DJIA), the most popular and widely publicized measure of stock market performance.
- The DJIA began in 1884, when the Dow Jones Corporation published the average closing price of 11 active stocks.
- Coverage expanded to 30 stocks in 1928.
- Since then, some stocks have been added and others deleted, but the sample remains at 30.
- Because of these changes, the DJIA is no longer a mathematical average of stock prices.
- Also, the evolution of the DJIA has obscured the meaning of a "point" change in the index.
- At one time, a one point change in the DJIA meant that an average share of stock changed by $1.
- Since this is no longer true, it is better to focus on the percentage change of the index rather than the number of points.
- Investors also use another popular benchmark of stock performance, the Standard & Poor's 500 (S&P 500).
- It uses the price changes of 500 representative stocks as an indicator of overall market performance.
- Because the sum of 500 stock prices would be very large, it is reduced to an index number.
- Unlike the Dow Jones, which focuses primarily on the NYSE, the S&P 500 reports on stocks listed on the NYSE, AMEX, and OTC markets.
- The NASDAQ also computes several measures of market performance for investors.
- In addition, there are more than 20 sub-indices that focus on everything from the size of the firms traded on the NASDAQ to the performance of individual industries.
Bull vs. Bear Markets
- Investors often use colorful terms to describe which way the market is moving.
- For example, a bull market is a "strong" market with the prices moving up for several months or years in a row.
- One of the strongest bull markets in history began in 1995, when the DJIA broke 4,000 - and then reached 12,000 five years later.
- A bear market is a "mean" or "nasty" market, with the prices of equities falling sharply for several months or years in a row.
- The most spectacular bear markets since the 1930s was in 2001-2003, when the DJIA lost more than 1/3 of its value.
trading in the future
Financial assets can be bought and sold in the future as well as the present.
Most buying and selling takes place in the present, or in a spot market. In this market, a transaction is made immediately at the prevailing price.
Sometimes the exchange takes place later, rather than right away. This occurs with a futures contract - an agreement to buy or sell at a specific future date at a predetermined price.
A futures contract can be written on almost anything, including the size of the S&P 500 or the level of future interest rates. In most cases, the profit or loss on the contract is settled with a cash payment rather than the buyer taking delivery.
An option is a special type of futures contract that gives the buyer the right to cancel the contract. For example, you may pay $5 today for a call option - the right to buy something at a specific future price. If the call option gives you the right to purchase 100 shares of stock at $70 a share, and if the price drops to $30, you tear up the option and buy the stock elsewhere for $30.
You could also buy a put option - the right to sell something at a specific future price. The put option, like the call option, gives the buyer the right to tear up the contract if the actual future price is not advantageous to the buyer.
Most buying and selling takes place in the present, or in a spot market. In this market, a transaction is made immediately at the prevailing price.
Sometimes the exchange takes place later, rather than right away. This occurs with a futures contract - an agreement to buy or sell at a specific future date at a predetermined price.
A futures contract can be written on almost anything, including the size of the S&P 500 or the level of future interest rates. In most cases, the profit or loss on the contract is settled with a cash payment rather than the buyer taking delivery.
An option is a special type of futures contract that gives the buyer the right to cancel the contract. For example, you may pay $5 today for a call option - the right to buy something at a specific future price. If the call option gives you the right to purchase 100 shares of stock at $70 a share, and if the price drops to $30, you tear up the option and buy the stock elsewhere for $30.
You could also buy a put option - the right to sell something at a specific future price. The put option, like the call option, gives the buyer the right to tear up the contract if the actual future price is not advantageous to the buyer.