Stock Basics

Shorting Stocks

May 9, 2010 By admin 1 Comment

When you short a stock you are betting that the price of the stock will go down. You do this by borrowing shares of stock from your broker and sell it. The money goes into your brokerage account and you later buy back the stocks you owe, called covering. If you price of the stock goes down, you spend less to buy back the same amount of shares you borrowed and thus you make money. If the price goes up, you have to spend more to buy the stocks that you borrowed and thus you will lose money.

Let’s look at an example:

Let’s say you tell your broker you want to short 100 shares of Google which is now trading at $500. You would borrow 100 shares of Google and sell it immediately giving you $50,000 in your account. Sounds good, but remember you still owe the 100 shares of Google back. Now suppose Google drops to $400 after missing on quarterly earnings. You decide its time to buy the stock back, or cover the stock. You tell your broker you want to cover the 100 shares of Google. You would then buy the 100 shares at $400 for a total of $40,000. You started with $50,000 on the initial sell and only had to use $40,000 to buy the shares back that you owed giving you a profit of $10,000.

Much of what happens with most online trading brokerages is behind the scenes. If you wanted to initiate a short on a stock you would specify the ticker symbol and amount of shares, much like buying stocks, but you would click on the ‘short’ button instead of ‘buy’. Then when you are ready to close the trade you would use ‘cover’ button to buy the shares back.

A few things of note regarding shorting stocks. First, you must have a margin account to short stocks in case the stock goes up, you won’t have enough to cover with sale and must borrow money. Secondly, sometimes shares are not readily available to be borrowed. Lastly, if the stock you short pays a dividend during that time you are short, you must pay the dividend.

Filed Under: Stock Basics Tagged With: Stocks

Buying Stocks

March 26, 2009 By admin Leave a Comment

The first question most beginners to the stock market have involves buying stocks. Let’s take a look at two ways you can buy stocks – brokerages and DRIPs/DIPs.

Finding a broker

The most popular way of buying stocks involves using a brokerage. There are two types of brokerages, full service and discount. Full service brokerages offer special attention to its clients and also charge heftier commissions. Discount brokers on the other hand while offering less personal attention, offer very low commissions.

Online discount brokerages such as E*TRADE and Scottrade have become a huge hit in the past several years and have opened up the market to the “average joe”. Traditionally it has been a haven for the rich, but nowadays just about everyone is involved in the stock market. Trade commissions have seen a huge decrease in costs as competition has become fierce.

Opening an account with a brokerage firm is very simple and much like opening an account with your bank. You can also deposit and withdrawal money from your brokerage account and some even offer check writing privileges against your cash balance. Once money is deposited in your brokerage account, you are ready to begin buying stocks.

Drips and Dips

A less popular way of purchasing stocks involves using whats called DRIPs and DIPs, or Dividend reinvestment plans and Direct investment plans respectively. Both plans allow you to invest directly with the company, saving you money on commissions. This is a great way to make smaller investments at regular intervals in a particular company. However, unlike a brokerage, you don’t have the flexibility and speed of moving your money around into different stocks.

Filed Under: Stock Basics Tagged With: Stocks

March 25, 2009 By admin Leave a Comment

What is a stock?

Stocks represent ownership in a company. The amount of ownership depends on the number of shares owned versus the number of issued shares. For example, if a company issued 100 shares of stock and you buy 5 shares of stock in that company, you own 5% of the company. As a stock owner, you are entitled to any earnings the company makes, any assets it owns and have certain voting rights. At the same time, you have limited liability. Stock owners are not personally liable for any loans the company may make.

A stock literally is a certificate of ownership in a company. In the old days, stock owners actually traded stocks with certificates by taking them to a brokerage before a trade was made. Nowadays, most brokerages hold the certificates electronically for their clients and trades are made in a matter of seconds.

Why are stocks issued?

Most companies start small and are private companies. We’ve all heard the stories of companies such as Dell that made its humble start in a garage and grew to be a multi-billion dollar success. How did Dell get there? Well as a company grows, it sometimes needs an infusion of money to keep pace with its growth. This money can either come from borrowing from a bank or by raising capital through issuing shares of stock. The great thing about issuing shares of stock versus borrowing is that the company doesn’t have to pay any of the money back. Instead, share holders buy into the prospect of the company’s value and stock price, rising in the future.

How can you buy stock?

Buying stock can be achieved in many ways. The first way is by opening an account with a brokerage such as E*TRADE or Scot trade. These accounts are much like bank accounts where you can deposit and withdrawal money. In fact some brokerages you can also write checks against any cash balance in your account. There is normally an initial deposit minimum of $500 to $1000. This is the balance that you will make your trades with.

DRIPs or Dividend Reinvestment Plans are also a way of buying stock through a company. They allow investors to invest small amounts of money are regular intervals.

Another way of buying stock is through a retirement plan such as an IRA. Again you can open an IRA account with many of the popular brokerage accounts. The main difference is that your capital gains are not taxed every year like a traditional brokerage account. Also you may not withdrawal your balance until a certain age or you face a hefty tax penalty.

A company’s 401k is another way of buying stock although you don’t really have the flexibility of choosing the individual stocks, but rather pick a mutual fund that purchases certain stocks for its portfolio.

Risks vs. Rewards

Owning stocks can be risky business as not every business is successful and in fact many go bankrupt. Some stocks are riskier than others, but the potential for reward is also greater. In the stock market, there is normally a correlation between risk and reward. Buying a stock like Wal-Mart may not be as risky as a smaller company, but also may not give you much upside potential as far as an increase in stock value. Everyone has their own risk tolerance and this should be considered before purchasing certain stocks.

Filed Under: Stock Basics Tagged With: Stock market, Stocks