How Stock Market Works


In my effort to further educate newbies in the field of stock market, I initiated this article for stock market beginners. You may call it Stocks 101 or Stocks for Dummies.

First and foremost, what is the stock market? A stock market is an avenue for companies and corporations to offer their shares in the public. Once a company listed their shares in the stock market, then the public is free to buy and sell those stocks. It works in a similar way to how you might sell and buy gold. So what’s the pros and cons of a company in listing their stocks publicly?

Pros:

1. To raise capital. Companies hire an advisor called underwriter to formulate the Initial Public Offering (IPO) price of the company’s stock depending on several factors. Then executives of these companies will conduct a roadshow usually out of the country to entice foreign investors to buy these shares. The IPO price is the starting price of the company’s stock in the stock market when it first traded publicly. An oversold stock mean that it did well in its initial public offering. It means that a lot of investors bought the stock. It can be twice or thrice oversold depending on the turn out of the IPO.

2. To know the market value of a company. One way to easily know the market value of the company is by knowing the price of its stock. This in turn will be multiplied by the total outstanding shares that the company holds. Here in the Philippines, the largest company in terms of market value is PLDT.

Cons:

Since the company’s stock is now open for public, it can be subject to several external factors. Investors can now play its stocks. It can now be a subject for scrutiny by investors and analysts. Also, it can be a subject for manipulation. A company that did well, meaning, it beats analysts estimates on its earnings and profits will probably go higher as investors buy these shares. In contrast, those that did not meet or has some problems in liquidity, credit, labor, compliance, etc. will be dumped by the investors that will lead to the so-called ‘equity dry up’. This led to the recent bankruptcy of Lehman Brothers.

So much for the pros and cons, we will now get into the basics of the stock market.

Once a company listed its shares in the stock market, this will be represented by a so-called Ticker Symbol. A ticker symbol is a short-cut name of the company. You won’t see the long name Philippine Long Distance and Telephone Company in the stock market. It may be hard to memorize and to recall. Instead, it is represented by the ticker symbol ‘TEL’.

An index tracks the movement of the stock market. The ups and downs of an index depends on the movement of the price of the stocks. You usually hear the index went up or down by so and so points. Different countries have different names for their indices for easy identification. In US, there are three indices. These are called a.) Dow Jones Industrial Average or DOW or DJIA. b.) NASDAQ and c.) S&P 500. In Japan, they called their index ‘Nikkei’. In Hong Kong, they call it ‘Hangseng’. In UK, they call it ‘FTSE 100’. In Germany, they call it ‘DAX 30’. Here in the Philippines, they call it ‘Phisix’.

Someone asks, is there a minimum amount to buy stocks? The answer is yes! Here in the Philippines, it usually takes a capital of Php 25,000 to open an account but some online trading platforms require just Php 5,000. All stocks have a minimum number of shares that each investor needs to comply. This is called Board Lot. The purpose of this is to avoid ‘odd lots’ and to facilitate easier trading. This depends on the price of a stock.

The movement of stock prices is also subjected to ‘fluctuations‘. This is also dependent on the price of a stock. Here in the Philippines, a stock with a price of 101 and up per share is subject to a fluctuation of 0.10. It means that it can move to a multiple of 0.10, lower or higher.

The table below tells the board lots and fluctuations of stocks here in the Philippines which are both dependent on its price:

Board Lots and Fluctuations

When you buy or sell stocks, you placed a so-called Order. A ‘buy order’ mean that you requested to buy a stock at a specified price. A ‘sell order’ mean that you requested to sell the stocks that you currently holds. Every order is represented by a price and volume. By volume, it refers to the number of stocks that you want to buy or sell. By price, it refers to the buy or sell price that you want. All these orders will be requested thru a stock broker. A stock broker will receive all these requests and will post it in the stock exchange. Once an order materialized, it is called ‘matched order’. Meaning, if you posted a buy order of 100 shares of TEL stocks at the price of 2,000, then another person posted a sell order of 100 shares of TEL at the same price of 2,000. And so your order has been matched! If you posted beyond the trading hours, then it’s called ‘off-hour order’ and your order will be exercised the next trading day. If you don’t have sufficient funds to buy a stock, then it will be a ‘declined order’.

Stock market is like any normal store. It has operating hours called trading time or trading hours. Depending on the country, the stock market normally operates from 9:30AM to 12:30 Noon. Some countries like Japan operates from 9AM to 3PM.

You’ve been hearing a lot about bear and bull markets. What do these terms mean? A bear market is a stock market where there are a lot of sellers than buyers. By law of supply and demand, since there are a lot of supply, in this case sellers of stocks, then the stock price will be bound to go down. Why is it called a ‘bear’ market? Just look how bear attacks. It fights by using its claws in the ‘downward’ position. In contrast, a stock market called a bull market is characterized by a lot of buyers than sellers. This is again by using the law of supply and demand. Why is it called a ‘bull’ market? Just look at how bulls attack. They have this set of thorns in the ‘upward’ direction when they fight with an enemy. When there is a bull market, stock ‘rally’.

A blue chip stock is a stock of a well-established company having stable earnings. The term ‘blue chip’ came from casinos where blue chips represent counters with the highest value. During trading, a stock can be called ‘most active’, ‘top gainers’ or ‘top losers’. A stock belonging to the most active list is a stock with a lot of buyers and sellers. These set of stocks are also called ‘movers’. Top gainers’ list are stocks with the highest gain in a single trading day while top losers are stocks with the highest loss in a single trading day.

A stock that belongs to the list of most active, top gainers and top losers is usually determined by its market volume and market value. A market volume refers as to how many shares were traded in a particular trading day. A market value, on the other hand, refers to the monetary value of all those traded stocks. You usually hear reports of, for example, 3 Billion shares with a value of 1.5 Billion ‘shook hands’.

You usually notice a color associated with a stock during the trading. This indicates the movement of a stock. A color red means that the stock is going down. A color green means that the stock is going up. And a so-called unch, meaning a stock that did not went up or down, is represented usually by a black or white.

Now why do investors buy stocks? Well aside from the ‘buy low and sell high’ strategy called capital gains of making nice income from it, a stock gives ‘dividends‘. These are profit shares given by the company for investors who bought their stocks. All companies listed in stock exchange disclosed their dividend pay-out. This declaration commonly involves two dates: The ‘Ex-Date’ and ‘Payment Date’. The Ex-date is the date on which you should have acquired the said stock. The Payment date is the date at which the dividend will be paid. Dividends may come in two forms: Stock dividend and Cash Dividend.In order to illustrate more of this, let’s view the example below:

– Ayala Corp. (AC) declared to give 20% stock dividend declaration ex-date June 1; payment date July 31. Cash dividend of Php 5.75 per share ex date September 1, payment date October 30.

– As an investor, if you want to take advantage, acquire as much stock as you can before the ex-date. If the investor bought 100 shares of AC before September 1, the he/she will have 120 shares by June 1. Aside from this, if he/she retained the said stocks then he/she could have probably earned an additional Php 690 come October 30.

One last way of earning from stocks is the so-called ‘stock rights’. It is the the option given to the present shareholders to buy additional shares of stock at a price lower than its market price. This is an additional opportunity for those who hold stocks of a company and one way to raise additional capital for the company.

Historical values of a stock also play an important role in assessing whether the value of a stock is cheap or expensive. A 52-week high means that it is the highest price of the stock achieved in a span of 1 year. Consequently, a 52-week low means that it is the lowest price of the stock achieved in a span of 1 year. A Year-To-Date (YTD) Yield represent just how much the stock moved up or down starting from the start of the year which is January 1. These two are both dependent on the present date and the closing price of the stock (the price of the stock when the stock market closed). To illustrate more of this, let’s view the example below. Consider the following prices as the closing price:

– SM Investments had a 52-week high of 400 and 52-week low of 185. If for example the date today is November 10, 2008, then the stock of SM achieved its highest price of 400 and lowest price of 185 from November 10, 2007 to November 10, 2008, a span of 1 year. In the case of YTD Yield, let’s say today the company has lost 35% of its value. This just means the stock has fallen 38% of its value since January 1, 2008.

Aside from the gauge of historical values of stocks, one way of assessing if a stock is cheap or expensive is thru its Price-Earning Ratio or so called ‘P/E Ratio’. This is the ratio of the stock price to the company’s earnings. The higher the P/E Ratio, the higher the profitability of the company. BUT do not solely rely on this ratio. It may indicate that a high P/E ratio means that the stock is overpriced.

You also hear the term ‘Technical Analysis’. This refers to the technique used by brokers and analysts to predict the future direction of a stock. They use charts and graphs and is usually based on the historical value of the stock. In using this, they can somehow know when a stock is cheap or not. However, this is not 100% accurate as no one can really predict the movement of the stock market.

Ok, we will now go to some terms that are used by analysts in stock trading:

Cost averaging – This means adding or buying more shares at a cheaper price and disposing it at a modest price so that the cost will eventually average out with the profit leaving a break even or a little income. This was a strategy to lessen losses. To illustrate it, let’s see the example. I bought 200 shares of AC at 250 per share. The stock went down to 150 per share. To take advantage of it, I will buy additional 200 shares. And so when the stock moved to at least a price of 200 per share, then I am break even. If I had not done it, then I will incur a loss when I sell it at 200 per share.

Window Dressing – It is another strategy used by fund managers towards the end of the year or fourth quarter. They buy stocks with attractive values and sell those ones with beaten prices so that their portfolio will look good to their clients. To illustrate this, a mutual fund company buys a stock whose trend is up and sell some of its shares in another stock whose trend is down, even at a loss.

Short Sell – This means that you sell stocks that you don’t have at the time of the sell. It is done with the intent of later buying the share at a lower price for a profit. Traders usually do this when there is an expected decline of a stock. When the stock price really went down, then the trader is well off. In contrast, when that expectation did not materialize, then the trader loses money. Recently, this practice was banned by Securities and Exchange Commission for manipulating the stock market.

Volatility – The volatility of the stock refers to its price movement. The larger the movement of the stock, the more volatile it is. This means that a stock which moved from 150 t0 350 then back to 250 per share in a span of 3 days is more volatile than a stock which moved from 150 to 200 to 175.

Here is a short video from Youtube on How Stock Market Works:

To learn on what stocks to pick, you may view my article on what stocks to buy and if you want to know some stock trading strategies, you can refer to my article on stock trading tips.

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Tyrone is a passionate financial literacy advocate. He started this blog on November 2008 when he watched The Secret which talked about Law of Attraction because he wanted to become a millionaire and wanted to know how a millionaire acts. At the age of 26, he achieved his first million. To find out more about him, click here or follow him at Instagram

43 responses on “How Stock Market Works

    • Pareho pala tayo! Wala akong muwang sa ganito pero sabi nga ni Warren Buffet, “Why invest in real estate when stock market is easy”. Mukhang madali lang talaga kapat you know the basics. Sa una lang medyo nakakahilo siguro but eventually when you learn how the game works madali nalang magpatuloy. Salamat dito kay Tyrone for this very informative post. Exactly what I needed.

      Cheers!

      Jonha

    • madali lang po sa stock market. mga kasambahay at driver nga ni bro Bo Sanchez is into stock market din. pwede rin po nyo subukan muna maglaro sa stock trading game ng PSE sa website nila(real time)… you can buy & sell stocks using your “start up capital of 1M”. pero iba pa rin thrill pag actual na. newbie in stocks po…

  1. i was enlightened ng konti. Ganun pala yung nakikita ko sa big screen sa may Ayala Ave. Yung mga current stocks blah blah blah ng isang company, Tapos may value doon at kung tumaas ba or bumaba ang stocks ng isang company (tama ba? stocks ang tawag? or stock value? hehe). Di ko yun ma gets dati at nag tataka ako bat pinapalabas doon yung mga number2x na di ko ma gets. Para pala yun sa mga public stock holders at mga taong may paki alam sa stock market 😀

    sana ma22nan ko din to ng maigi. Magbabasa pa ako ng articles mo idol 😀 hehe 🙂

  2. now it clears my minds about basic stocks, you’re my on-line mentor. i have no one to ask ideas about stocks but through the net and yours is an unselfish serving of heaps and heaps of info about stock essentials, daghang salamat!ü added your site in my fave list 😉 hoping to start in stocks within this year.

    • ako pod ako na sya gi-add na favorite list.. daghan salamat talaga Tyrone. I hope you will be reps and myself’s mentor.. mahirap ang landas ng “financial freedom” and “financial literacy” if mag-isa ka lang and walang taong magaling na magtuturo sa yo o di kaya mag guguide… Mentor us naman…

  3. Hi,
    Thanks for sharing your wonderful knowledge. Glad to have people like you online. Stock-trading “sounds french to me” and with your website’s help, I can always go back and read all over again until it gets down to my head.
    Many thanks.

  4. very informative. just as I needed someone to ask about stock trading then i found your site… it made my decision making easier… still need to learn more. i appreciate your time and effort in putting up this article =)

  5. Tyrone,

    Kung may schedule talaga ang selling at trading like day trading, kailangan ba talagang tutok ka sa computer neto buong araw? Hindi ba pwede na part-time or may pagka passive income lang itong stock investing?

    • You don’t need to be necessarily in front of the computer. You can invest for passive income in the stock market by buying long term and blue chip stocks which gives dividends.

    • Tyrone,

      So for a start, do you suggest to buy blue chip stocks and hold it for a long term than short terms? Do you think it’s best to start with Citiseconline?

    • Yes, I would advise that. Citisec is I think the best when it comes to providing the most detailed information to its stock traders. However, personally, I chose BPI Trade because of the convenience it brings me by linking my own BPI savings account to my BPI trading account. You can transfer funds easily online. Transfer sales proceeds of your stocks from BPI Trade to BPI Savings. Vice versa, you can also transfer funds from savings account to trading account to fund your stock market trading.

  6. As part of my investing plan, I started learning about stocks just this month of November and I found your site. So far, I find your site very informative and most relevant. I’m thinking of sharing your thoughts on my blog with a link back to your site. Thanks for educating novices like us online. Grace and peace!

  7. Ayala Corp. (AC) declared to give 20% stock dividend declaration ex-date June 1; payment date July 31. Cash dividend of Php 5.75 per share ex date September 1, payment date October 30.

    – As an investor, if you want to take advantage, acquire as much stock as you can before the ex-date. If the investor bought 100 shares of AC before September 1, the he/she will have 120 shares by June 1.

    I think there’s an error here. I presume you should’ve bought before June 1 so you’ll have 120 shares by July 31. 🙂 🙂

  8. Hi Tyrone,

    The company I am working right now has this program called Employee Stock Purchase Program (ESPP) wherein the company deducts 1~10% from our gross income and invests the accumulated amount every six months to purchase stocks of the company (Wdc). Do you think this would be better than say using Citiseconline or BPI Trade?

    • Hi Alvin,

      It can be good depending on the performance of your company. In this situation, you don’t have control over which stocks to buy because the company is investing in your behalf and they are only buying their own stock. The company is bias in this case. All eggs are in one basket which is the stock of your company. What if the company does not perform well? What if there are major issues affecting the stock of the company?

      I would say it is still better to diversify your investments in several stocks, not just in one stock alone. In this case, I think it is better using Citiseconline or BPI Trade.

  9. At last I got some ideas. I am so desperate in looking this kind of info.

    Thank you Uncle Tyrone. Now I have to start hunting on where I put my small hard earned money. Any suggestion po.

    Thank you very much.
    Vicky

  10. hi sir tyrone, can u clarify more on fluctiations..

    “The movement of stock prices is also subjected to ‘fluctuations‘. This is also dependent on the price of a stock. Here in the Philippines, a stock with a price of 101 and up per share is subject to a fluctuation of 1.00. It means that it can move to a multiple of 1, lower or higher, but it cannot move 0.25. Therefore, you cannot buy or sell it at 101.25 or 101.50”

    Are there rules in selling ur shares at a price? for eg u buy 1000000 shares at a price of 0.01 then sell it lets say 0.011, is this possible?

    newbie here tnx…

  11. An initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. Initial public offerings are used by companies to raise expansion capital, to possibly monetize the investments of early private investors, and to become publicly traded enterprises. A company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Although an IPO offers many advantages, there are also significant disadvantages.^,..

  12. I just stumbled into your blog today and in few hours of reading, I’ve learned a lot! This has just given me more confidence to finally start in stocks. 🙂

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