Characteristics of the Market

The words like “Stock market crashed”, “Government bailout”, “End of American capitalism”, “Major Banks Collapse” and “Trillions of dollars wiped off” will always linger in the minds of people who have lived through the 2008 stock market crash and lost most of their money. In the biggest single intraday point loss ever, Dow Jones fell nearly 778 points after $700 million government bailout plan was rejected by the house.

 

In spite of having the world class intelligence and state-of-art technology, it is not uncommon for experts to miss the blind spots and make mistakes. Market has always been and will always be unpredictable so before you even think about any market based investment, it is imperative to understand that market changes every moment. It has certain characteristics and it is highly impossible to predict the behavior of the market. Several events such as- Income statements, Balance sheets, Earning reports, News, Economic reports, Federal announcements, Terrorist attacks, Analysts’ opinion and recommendations and Technical indicators may have a severe impact on the market’s behavior. Old trends and patterns do not determine the future direction of the market. Here are some of the important factors that you need to consider while you try to determine the future behavior of the market:

Volatility

Stock markets are volatile. Price changes of several percentage points within a short period are common. Markets usually react to news events, such as corporate earnings, government economic reports and geopolitical events. Software algorithms and automated trading strategies, along with the increased participation of investors, have increased the complexity and volatility of stock markets. You can hedge against market volatility by diversifying your portfolio. Successful investors ignore short-term fluctuations because stock prices reflect the underlying fundamentals over time.

Selection

Markets offer a wide selection of stocks to suit different risk tolerances and financial objectives. Aggressive investors can buy the stocks of newly listed companies and growth companies. Although these stocks are riskier than the stocks of established companies, you could benefit from significant price appreciation. Conservative investors could buy dividend-paying stocks, which generate regular income and some potential for price appreciation. You can find stocks from major industry sectors and sub-sectors within each industry. For example, you could invest in microprocessor and software companies within the technology industry and in department stores and specialty retailers within the retail industry.

Liquidity

Stock markets provide liquidity because they bring together investors and businesses from all over the world. Liquidity results in narrow bid-ask spreads, which means small differences between what buyers are offering and what sellers are asking for stocks. The result is order fills at favorable prices. Information technology plays a role by increasing the speed at which the markets execute trades and disseminate information to investors and other market participants. The free and transparent trading that takes place in the stock market prices is according to demand and supply, bid and ask. In this way it provides liquidity for investors seeking to transact sales of their holdings through this active pricing mechanism.

Global

North American and other stock markets are interconnected and interdependent. For example, Asian and European companies list on North American exchanges, while U.S. and Canadian companies list on European and Asian exchanges. Individual and institutional investors can trade stocks using 24-hour electronic communications networks. A stock market drop in Tokyo overnight can spread to Frankfurt in the early morning hours and hit New York in time for the opening bell. Similarly, news events in Europe can ripple through global stock markets in minutes.

Regulated

Regulations are necessary for fair and efficient markets. The U.S. Securities and Exchange Commission regulates the U.S. securities industry, along with the New York Stock Exchange and other markets. Securities laws ensure that investors and other market participants have access to the necessary information in a timely manner. The stock market provides a degree of protection to investors through oversight by the SEC, FINRA and other legal regulatory and self-regulating bodies on state and professional levels that serve to create an organized and liquid group of stock exchanges and stock trading platforms.

Gains and Losses

You are not guaranteed to make money when you invest in the stock market. But unlike with savings accounts, certificates of deposit or similar investments with fixed-rate returns, there is no limit on the money you can make in the stock market either. If you sell stock for more than you paid, you record a gain. Sell it for less than you paid and you incur a loss. Either could have tax ramifications.

Diversification

Just as there is safety in numbers, there is security in diversity. Investing in more than one company's stock could protect you. Should the price of one company's stock plummet, gains in others might minimize your overall loss or perhaps even increase your total return. Mutual funds are popular among investors because they allow you to spread your investment among shares of several companies. You also can diversify by yourself by directly buying shares in different companies.

Stock Categories

Mutual funds and investors often focus on stocks with similar characteristics. Income stocks pay large dividends, but their prices do not rise much, according to the New York Stock Exchange’s Learning Center. Established companies with smaller dividends but steady prices are considered blue-chip stocks. Growth stocks belong to young companies that pay little or no dividends but offer greater chances for long-term price increases – or decreases. The prices of cyclical stocks, like those of home builders and automobile manufacturers, fluctuate with economic expansions and slowdowns. Conversely, defensive stocks, such as those of food and beverage manufacturers, maintain their values during recessions.

Indicators

Number of shares traded, closing prices, the change from their previous prices and the 52-week highs and lows are among the more rudimentary measures of a stock’s performance. Price-to-earnings ratio also is a standard. If, for example, a share sells for $50 and the company earned $5 a share, then the P/E ratio is 10. Investors might buy if they feel the ratio is low and that the price might rise. Or they might sell if they expect the price to soon drop because they consider the ratio to be too high.

Bulls and Bears

Do you see the proverbial glass of milk as half-full or half-empty? Your answer would indicate if you were a bull or a bear. Bears expect the stock market to drop while bulls bet that it will rise. Similarly, when prices generally decline over a prolonged period of time, it is considered to be a bear market. Sustained increases are called bull markets. You might buy or sell stock based upon whether you expect the market to rise or fall.

Booms and Busts

Easy come and easy go. Investors occasionally push prices of hot stocks or industries, or even the market as a whole, to unsustainable highs. The inevitable bust then follows. For example, stock prices soared for companies that capitalized on the adoption of the Internet in the late 1990s. University of Maryland researchers found that investors poured $880 billion into the telecommunications industry from 1997 to 2002, only to see half of it dissipate within the next five years.

Growth Capital

Issuing of stock is the cornerstone of capital formation for enterprise in capitalist economic systems. The stock market provides a way for companies to issue stock to the investing public.

Transparency

The public nature of trading maintains transparency in financial transactions. Efficiency, growth, freedom and variety are all possible because of transparency that allows all participants to access the bid and ask prices of all securities traded on the market and because all participants have access to the same information.

Economic Indicator

One of the ten components of the Leading Economic Indicators is made up of the Standard & Poor's 500 Stock Index, one of the major stock market indexes. The direction of trading activity in the stock market provides an indication of the state of commerce and overall confidence in the economy.

Regulated Risk/Reward

An organized and regulated stock market serves as a way for investors who seek large returns on their investments to access organized, liquid, regulated and transparent risk investing.

(Reference: http://www.zacks.com)

Investment, Asset Classes and Financial Markets

When you talk to someone about “investing”, two words that you will come across frequently are “Investment” and “Market”. So what is an investment and what’s a market?

What is an Investment
People have been confusing the word investment with a lot of things which have nothing to do with investment. Now a days you see people “investing” in their big houses, cars, TVs, education and the word investing is replacing so many other words just to justify an “investment”.

Investment means “a purchase” which is supposed to generate a profit or an income. In broad category, we can categorize investment into three categories:

1. Ownership e.g. Business, Real Estate, Stocks, Precious metals (like gold, silver)
2. Lending e.g Peer-to-peer lending, Bonds, Certificate of deposits (CDs), Treasury inflation protected securities (TIPS)
3. Cash Equivalent e.g savings account, money market funds

But investment companies categorize it into four groups known as Asset Classes - 

1. Equity e.g Stocks, 
2. Fixed Income e.g. Bonds 
3. Cash Equivalent e.g. Money Market Instruments such as Treasury bills, Certificates of deposit, Bills of exchange, Asset backed securities and Repurchase agreements
4. Alternative Investments e.g Real Estate, Commodities, Derivatives, Hedge Funds, Index Funds, Funds of Funds, Mutual Funds, Exchange Traded Funds (ETFs), Private Equity, Venture Capital, Options, Futures, Forex, Annuities

So basically an asset class is a group of financial assets / securities that are behaviorally and characteristically similar and are subject to the same laws and regulations.

Investopedia defines security as “A security is a financial instrument that represents an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option. A security is a fungible, negotiable financial instrument that represents some type of financial value. The company or entity that issues the security is known as the issuer”.

Here I am just giving you an overview of everything and later we will get into the details of each of these to see what exactly they are.

What is a Market
The yield of every investment depends on how the “market” is doing. When you invest your money with investment companies, they further invest that money in the market through various investment vehicles to generate profits. These investment vehicles may have different level of risk associated with them. High risk investment vehicles such as stocks, options and futures usually yield high returns and low risk investment vehicles such as CDs and Bonds yield comparatively low returns.

Market, also called financial market, is a place where these securities are traded i.e. Where they are bought and sold. The funniest fact of the market is there are two sides (buyer and seller) of this trade and both sides expect to make profit with their respective transactions.

Financial market is further categorized as- Capital Market and Money Market.

Capital Market
Capital market primarily provides a platform for trading of securities in order to raise long term funds for corporations, government, banks or any other issuing group. Let’s take a look how it works-

First time when a company seeks to raise funds through public investments in its shares it goes through investment banks and underwriters to issue the shares, distributes prospectus, and conducts road show (marketing). Investment banks advise the company about the best way to raise funds, pricing financial instruments and how to meet the regulatory requirements. Investment banks have to outbid other institutions who also want to handle the transaction on behalf of the issuer but if the market demand for the securities is weaker than expected, investment ban may not be able to make a nice spread (spread is the profit margin) or may even end up in loss.

Underwriter is the company that works with the issuing company to determine the “right price” of the security offerings and manages the issuance and distribution of securities, buys securities at a predetermined price from the issuer and re-sells them to the public through its distribution network at an exchange. Underwriter received underwriting fee and makes some profit in the re-selling the stocks to public that is also called initial public offering (IPO).

In the above scenario, investment bank operates in Primary Market while initial public offering is made in the Secondary Market, if the company meets the conditions of Size, Liquidity and Ownership (public float) . Stock exchanges are characterized by a summary index called stock index or stock market index which is typically computed as a weighted average price of the selected stocks being traded in that exchange. NASDAQ composite, Dow Jones Industrial Average, and S&P500 are he examples of stock indices.

An exchange can be used by the companies to seek new capital, additional equity capital for expansion or new projects, buy back shares if funds can not be invested more productively and take over or merger with other companies.

Just like corporations need money to expand into new markets, governments also need funds for things like building new infrastructure and improvement of old infrastructure but governments do not issue stocks (remember stocks are the ownership equities) . Governments issue various bonds to borrow money from the public for a certain time.

Depending on the type of security being traded, capital market is further categorized into:

1. Equity Market
2. Debt Market
3. Derivatives Market
4. Commodity Market
5. Forex Market (also currency market)

Money Market
Money market is used to raise short term funds, usually for one year or less. From the investors’ point of view money market is a good place to “park” funds. Money market ensures corporations and governments maintain adequate level of liquidity on daily basis. Companies may even borrow short term funds from the money market for things like running payrolls.

Money market instruments include Treasury Notes, Bank Accepted Bills, Commercial Papers, Certificates of Deposit.

But remember regardless of the term (long term or the short term) and the type of market (capital market or money market), all types of investments have some inherent risks involved. No investment is safe and even money market investments may also experience negative returns.

Welcome to Wall Street Investing: The Smart Investing Blog

"Wall Street”! Doesn’t that word ring a bell and reminds you of filthy rich investors who sit in luxurious offices, own expensive estates and fly in private jets, the people who know how to make money regardless of the direction of economic swing.

Internet is full of websites, videos, articles and blogs about how to be rich buying and selling stocks, investing in real estate etc. but it all may not be as easy as it sounds. You must be properly educated and well informed about investing, various investment vehicles, investment strategies, level of risk associated with each type of investment vehicle before you actually start investing money and above all you must be aware of what you are getting yourself into. Is it really meant for you? And that’s what the purpose of this blog is- Education and Information.

If you are someone who has enough money to gamble with in stock market or an investor playing with house money or even if you are someone who wants to learn not just about investing but about smart investing- Welcome to Wall Street Investing: The Smart Investing Blog.

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Disclaimer

Do not act based on anything you might read on this blog. The content of this blog is purely for informational purposes only. The information on this blog should not be construed as a recommendation, suggestion, advise or offer to buy or sell any securities, make any real estate related investments, suitability of any investment strategy to any reader and does not encourage anyone to take any position in any market.

All the information, data, research reports or insights have been either derived or obtained from various sources or may be the independent opinion of the writer and writer does not guarantee the accuracy of any information, data, research reports, insights provided on this blog. Writer of this blog does not bear any responsibility for any tangible, intangible or punitive damages arising due to any such information or content provided on this blog.