Navigating the
Stock Market
Stocks
Stocks are a share in the ownership of a company.
Stock represents ownership of a company’s assets and
earnings.
As you acquire more stock, your ownership in the
company increases.
Shares, equity, and stock all mean the same thing.
Being an Owner
Owning a company’s stock means that you are a part owners
(shareholders) of a company. As such, you have a claim (based
on the percentage of shares you own) to what the company
owns.
This means that you own some of the furniture, the
trademarks, and the contracts of the company. Also, you are
entitled to share in the company’s earnings as well as the
voting rights as specified in the stock.
Being an Owner (continued)
There are 2 types of stock ownership:
Preferred stock: dividends are paid to preferred stock holders
first.
Common stock: able to vote but are paid dividends last.
Larger amount of shares are available.
Dividend:
Payments made to shareholders by corporations.
When a company earns profit, the company can use the
money to either re-invest in the business (retained earnings)
or to give shareholders as dividends or share repurchase.
Many corporations keep a portion of their profit and pay the
remainder as a dividend.
Dividend options:
Corporations can pay dividends in the form of cash, stock or
property.
Most large profitable companies offer dividends to their
stockholders. Their share prices might not move much, but
the dividend they pay make up for this.
Higher-growth companies typically don’t offer dividends
because their profits are reinvested to help continue their
higher than average growth.
Stock symbols
Stocks listed and traded on U.S. exchanges such as the
NYSE have symbols with up to 3 letters. Nasdaq-listed stocks
have 4 letter symbols.
Examples:
XOM: Exxon
BAC: Bank of America
AAPL: Apple
GOOG: Google
GE: General Electric
Bid Price:
When you are selling your shares of a stock, the bid price is
what the buyer is willing to pay for your shares. This Bid Price
offers you an exact price of how much you can sell your shares
for.
Ask Price:
The Ask Price is the price at which a seller is willing to let go of
her shares. More specifically, this is the price you will buy your
stocks at.
The PE Ratio provides a numeric representation of the value
between the stock price and earnings. To derive the PE Ratio
you divide the share price by the company’s Earnings Per Share.
Example:
Coca Cola’s (KO:NYSE) stock price (Price per Share): $66
Coca-Cola’s Earnings-per share (EPS): $5.26
Coca-Cola’s PE Ratio: $66 / $5.26 = 12.55
Pepsi’s (PEP:NYSE) stock price (Price per Share): $69
Pepsi’s Earnings-per share (EPS): $3.73
Pepsi’s PE Ratio: $69 / $3.73 = 18.50
From our calculations, we can see that Pepsi has a higher PE
Ratio than Coca-Cola.
How to interpret the P/E Ratio
High P/E Ratio may mean:
Market sentiment: An overly optimistic P/E Ratio can indicate the market
expects big things from this company. The company has high growth
possibilities.
Lifecycle: The company could be entering into the Growth or Shake-Out stage of
its lifecycle.
Industry: Specific Industries have a certain level for the P/E Ratios. For example
most technology companies have high P/E Ratios.
Cover priced or over-bought: A high P/E Ratio can indicate a given stock is
priced to high and ready for a correction. This means that it might be overvalued. Be sure to compare against industry norms.
Low P/E Ratio may mean:
Lack of confidence: A low P/E Ratio may indicate a lack of confidence in the
future of the company.
Lifecycle: The company could be in the Mature or Decline stage of its lifecycle.
Industry: Specific Industries have a certain level for the P/E Ratios. For example
most utility companies have low P/E Ratios.
Sleeper: A low P/E Ratio might be a sleeper just waiting to be discovered. This
means that it might be undervalued, and a perfect time to start buying the
shares.
Dividend Yield:
A ratio showing how much a company pays in dividends each
year relative to its share price. Assuming that the stock price
does not change, the dividend yield is the only return on the
stock holder’s investment.
Dividend yield is a way to measure how much “bang for
your buck” you are getting from your investment
through dividends.
Example:
If two companies pay the same annual dividends of $1 per share
per year, but company 1 stock sells at $20 while company 2
stock sells at $40, then company 1 has a dividend yield of 5%
while company 2 is only yielding 2.5%.
Assuming that all other factors are the same, an investor that is
looking to add to his or her income would likely prefer company
1 stock over that of company 2 stock.
Market Orders are an order to buy or sell a stock at the best
available price.
Generally, this type of order will be executed immediately.
However, the price at which a market order will be executed is
not guaranteed. It is important for investors to remember that
the last-traded price is not necessarily the price at which a
market order will be executed. In fast-moving markets, the
price at which a market order will execute often deviates from
the last-traded price or “real time” quote.
Market orders
Your market order is executed at the best price obtainable
at the time the order is executed. In other words, with a
market order the fact that the order will be filled is all but
guaranteed (subject to the availability or liquidity of the
stock), but the price at which it will be filled is not.
The market is dynamic. Prices are changing continuously in
the market as the minutes go by. Orders are executed with
priority rules, delays in execution can occur due to market
demand of a security, and in the meantime a market price
can change as a result of investor demand and other
factors. Large orders can also take longer to fill and can
move the market (price and volume) for the stock,
sometimes to your disadvantage.
Limit orders
In contrast to the market order, there is another type of
order called a "limit order" that does guarantee the price
but does not guarantee an execution.
Limit orders require you to place a limit on the amount you
are willing to pay to buy a stock or on the amount you are
willing to accept to sell a stock. Naturally, you will accept
more favorable prices if you can get them.
Different types of orders allow you to be more specific about
how you'd like your broker to fulfill your trades. When you place
a stop or limit order, you are telling your broker that you don't
want the market price (the current price at which a stock is
trading), but that you want the stock price to move in a certain
direction before your order is executed.
With a stop order, your trade will be executed only when the
security you want to buy or sell reaches a particular price (the
stop price). Once the stock has reached this price, a stop order
essentially becomes a market order and is filled. For instance, if
you own stock ABC, which currently trades at $20, and you
place a stop order to sell it at $15, your order will only be filled
once stock ABC drops below $15. Also known as a "stop-loss
order", this allows you to limit your losses. However, this type
of order can also be used to guarantee profits. For example,
assume that you bought stock XYZ at $10 per share and now
the stock is trading at $20 per share. Placing a stop order at $15
will guarantee profits of approximately $5 per share, depending
on how quickly the market order can be filled.
Stop orders are particularly advantageous to investors who are
unable to monitor their stocks for a period of time, and
brokerages may even set these stop orders for no charge.
Buy limit order example:
THI is selling for $84 a share. You think the stock could decline in
the short-term and then rebound strongly upward. So you place
a limit order GTC (Good Till Canceled) to buy THI at $82. (Any
price different from the current market price is said to be "away
from the market”.)
Now the broker/dealer's computers monitor your order and
when the stock price hits $82 your buy limit order is executed at
that specific price. If the stock price does not decline to $82,
your limit order is not executed.
Sell limit order example:
You own Tim Hortons stock, which is trading at $84. You think
the stock can still go higher. So you place a sell limit order at
$88. When the stock price rises to $88, your limit order is
executed, subject to there being enough demand for the stock
at your specific price. If the stock price does not rise to $88,
your limit order is not executed.
Risks of limit orders:
Limit orders give you more control over execution price, but
control also comes with certain limitations that you should be
aware of: i.e. you may miss owning or selling stock, depending
on the circumstances. The stock may never reach your limit price
and your limit order will not execute. For example, in the Sell
Limit Order example above, if Tim Hortons only reached $87 and
then started to fall, your limit order would not have executed
and you'd still own the stock as its price drops.
Fail to execute: Even if your stock reaches the limit price, your
limit order may not execute if there are orders ahead of yours at
the same limit price. The orders in line ahead of you must be
filled first and there may not be enough stock available to fill
your order when its turn comes.
STOP ORDER:
An order to buy or sell a stock when its price surpasses a
particular point, thus ensuring a greater probability of achieving a
predetermined entry or exit price, limiting the investor's loss or
locking in his or her profit. Once the price surpasses the
predefined entry/exit point, the stop order becomes a market
order.
TRAILING STOP:
A stop order that can be set at a defined percentage away from a
stock’s current market price. A trailing stop for a long position
would be set below the stock’s current market price; for a short
position, it would be set above the current price. A trailing stop is
designed to protect gains by enabling a trade to remain open and
continue to profit as long as the price is moving in the right
direction, but closing the trade if the price changes direction by a
specified percentage.
Traders and investors who seek to limit potential losses can
use several types of orders that can get them into and out of
the market at times when they may not be able to place an
order manually. Stop-loss and stop-limit orders are two such
order types that can accomplish this. But it is critical to
understand the difference.
Stop Loss Orders
There are two types of stop-loss orders:
1) Sell-stop orders protect long positions by triggering
a market sell order if the price falls below a certain level. The
underlying assumption behind this strategy is that if the price
falls this far, it may continue to fall much further, so the loss is
capped by selling at this price.
Example:
Frank owns 1,000 shares of ABC stock. He purchased the stock at
$30 a share, and it has risen to $45 on rumors of a potential
buyout. He wants to lock in a gain of at least $10 per share, so he
places a sell-stop order at $41. If the stock drops back below this
price, then the order will become a market order and get filled at
the current market price, which may be more (or more likely less)
than the stop-loss price of $41. In this case, Frank might get $41 for
500 shares and $40.50 for the rest. But he will get to keep most of
his gain
Stop-Limit Orders
These orders are similar to stop-loss orders, but as their name
states, there is a limit on the price at which they will execute.
There are two prices specified in a stop-limit order; the stop price
that will convert the order to a sell order, and the limit price.
Instead of the order becoming a market order to sell, the sell
order becomes a limit order that will only execute at the limit
price or better. Of course, there is no guarantee that this order
will be filled, especially if the stock price is rising or falling rapidly.
Stop-limit orders are sometimes used because if the price of the
stock or other security falls below the limit, then the investor
does not want to sell and is willing to wait for the price to rise
back to the limit price.
Example:
Frank’s ABC stock never drops to the stop-loss price, but it continues to rise and
eventually reaches $50 a share. He cancels his stop-loss order at $41 and puts in
a stop limit order at $47 with a limit of $45. If the stock price falls below $47,
then the order becomes a live sell-limit order. If the stock price falls below $45
before Frank’s order is filled, then the order will remain unfilled until the price
climbs back to $45.
Many investors will cancel their limit orders if the stock price falls below the limit
price, because they placed them solely to limit their loss when the price was
dropping. Since they missed their chance to get out, they will then simply wait for
the price to go back up and may not wish to sell at that limit price at that point,
because the stock may continue to rise. If Frank could not get out at $45 or better
and the stock price falls back to $40, then he may be wise to cancel the order,
because if it rises back to $45, it may keep going.
As with buy-stop-loss orders, buy-stop-limit orders are used for short sales where
the investor is willing to risk waiting for the price to come back down if the
purchase is not made at the limit price or better.