The center of our Nation's economy does not rest at Fort Knox with its millions of dollars worth of gold, or even the Treasury that prints the money that you use. At the center of the United States economy is Wall Street. Almost every larg e company in the US and around the world is traded on a Stock Exchange; from McDonalds to Lockheed Martin.
To learn more about how the stock market can earn money, and even keep the economy healthy, we have to look at how it works. With this tutorial, you will learn how the stock market was created and about the inner workings of the Stock Exchang e, brokerage firms, buying and selling, mutual funds, and much more.
Some of you might be wondering why should you care about the stock market. Maybe you are too young to be investing, or can't see how the market relates to your every day life. The fact is, even if you have no money in the stock market, or ar e in school, the stock market does affect you. It affects everything you do, from going to the mall, to buying that new outfit you have always wanted. After all, Calvin Klein has to get money to make those outfits!
This tutorial is designed to let you decide what you want to learn about. It is recommended that you read the topics sequentially, but it is not required. If you already know about a topic you may want to skip over it. After all, learning s hould be fun. So jump right in and select a topic.
Right now, the New York Stock Exchange has billions of dollars changing hands every day, with thousands of companies being traded, and millions of people being affected. If we trace the roots of the New York Stock Exchange to its beginning, we would find that it started out as dirt path in front of Trinity Church in East Manhattan 200 years ago. At that time, there was no paper money changing hands, or even the idea of stocks. Rather, they traded silver for papers saying they owned shares in cargo, that was coming in on ships every day. The trade flourished.
During the American Revolution, the Colonial Government needed money to fund its wartime operations. One way they did this was by selling bonds. Bonds are pieces of paper a person buys for a set price, knowing that after a certain period of time, they can exchange their bonds for a profit. Along with bonds, the first of the nation's banks started to sell parts or shares of their own companies to people in order to raise money. In essence they sold off part of the company to whomever wanted to buy it, which is the essence of the modern day stock market.
Wall Street was becoming a major center of these transactions, and in 1792 twenty-four men signed an agreement that started the New York Stock Exchange (NYSE). They agreed to sell shares or parts of companies between themselves and charge people commissions, or fees, to buy and sell for them. They found a home at 40 Wall Street in New York City. As they grew they later moved into what is currently the New York Stock
The 1900s brought the Industrial Revolution, and along with it, a boom in Wall Street. Everybody wanted a piece of the action, and Wall Street grew. The New York Stock Exchange was not the only way to buy stocks at that time. Many stocks that were deemed not good enough for the NYSE, were traded outside on the curbs. This so called "curb trading," has now become the American Stock Exchange (AMEX).
Today, the New York and the American Stock Exchanges, have been joined by the NASDAQ, and hundreds of local and international Stock Exchanges, that all play a part in the national and global economy.
Lets say you hear a tip that McDonalds is coming out with a brand new product that is supposed to double their business. You think to yourself, "Darn, I wish I owned that company." Well you can. McDonalds, along with thousands of other companies, lets the public buy part of its company. It does this through selling shares. A share is simply a piece of paper that says you own part of a company. This part is usually extremely small, perhaps thousandths of a percent of the total company, but, hey, it is a beginning. You decide you want to buy part of McDonalds. You run home, and count up all of the money you have been saving, and find out you have 250 dollars. Well you are not going to be able to buy the whole company, but it is a start.
You've got the money, you know what stock you want to buy, now what? Do you go to the grocery store and ask for a dozen shares of McDonalds. Not exactly, but close. You don't go to a grocery store, but rather you call a broker. A brokerage house is your supermarket of stocks. You call up any broker and say, "Charles, I've got 250 dollars, and want to buy as much McDonalds as I can."
Charles in return tells you, "Let's see, a share of McDonalds costs 20 dollars (Not the actual price), and I am going to charge you 50 dollars for my services, so you can buy 10 shares of McDonalds. " You then give Charles the money, and you get the stock. (They usually don't give you the paper stock certificates, but they transfer ownership over to you.) Voila, you have just bought stock in a company!
Sounds simple enough, right? Actually it is not if you look at it from the broker's point of view. When you told the broker you wanted those 10 shares of stocks, he did not magically buy them for you, or already own them. Rather, he sent a message to another person who is working down on the floor of the New York Stock Exchange (or any other stock exchange). He tells this person to buy these stocks for you. This person is called a "Floor Broker."
Now this person goes to the part of the Stock Exchange that is allotted to this particular stock. Here there are companies that specialize in this stock. This means that they will usually, if not always, buy and sell from people at the normal price. The floor broker then buys your ten shares from one of these people, reports his trade through the hundreds of computers on the floor, then reports to his colleagues back at the brokerage house that he bought the stock.
The broker keeps a record that you own that stock, rather than sending you the actual paper stock certificates. If you ever want to sell them, your broker will sell them, deduct his commission, and then give you the money.
Got all that? Well if you did not, here it is again using a simplified example. When you want a stock, you call a broker. The broker calls a person on the floor (usually an employee of the broker). This person runs to the space that is allotted to this stock. He then buys the amount of stock from the specialists, or companies, that are there to sell and buy on a regular basis. He then tells the firm he bought it, and then you have your stock.
Well it was pretty easy to buy a few shares of McDonalds, but what if you are not sure about which stock you should buy? Maybe you would rather let a professional choose the stocks for you. Well, you are not alone. Millions of people turn over control of their finances to professionals by buying Mutual Funds. There are two types of mutual funds, open and closed.
Open mutual funds, such as Fidelity Magellan, let people put their money in them, just like a bank. The difference is that banks take your money and lend it out, and then pay you interest on the money you gave it. This is static, in that it does not change. When you put your money in, the bank usually says we will give you 3 percent interest. When you put your money in a mutual fund, they take that money, along with that of millions of other people who are investing, and buy stocks and bonds with it. They then take out part of the profits for themselves, a commission, and give you your share.
Closed end mutual funds, are similar to their open counterparts in that you turn over control of your money to professionals but, rather than putting money in them like a bank, you buy shares like a stock. This means that a closed end mutual fund acts just like any other stock on the Stock Exchange, they have Ticker Symbols, and are traded. The difference is that these mutual funds, instead of making burgers, or creating airplanes, take the money they have, invest it, and return the profits to the share holders.
Well, we have now learned how to hand over money to people, in exchange for stocks, but what is to stop them from cheating you, or from running off to Mexico with your hard earned 250 dollars that was supposed to go to McDonalds? Well to keep brokers honest, the government has put into place many commissions, and organizations. Of these organizations the major player is the Securities Exchange Commission (SEC).
The SEC is a government agency whose purpose is to regulate the securities industry (the stock markets). It was created after the Great Depression when Congress passed the Securities Exchange Act of 1934. This agency decides what is legal, and prosecutes those who break the rules, along with setting many standards for brokers and investors alike. All companies traded on the many stock exchanges across America have to be registered with the SEC. Each must follow rules about what they can do with their stock, how they can advertise, and much more.
Most of the rules placed on companies are to prevent the owners and employees from using insider information. Insider information is information that a person obtains about a company that is not available to the rest of the public, that can be used to their advantage while buying stocks.
For example, lets say you are the CEO of company XYZ, and company ABC is now in negotiations with you to merge, and create a much larger company called GHI Inc. Now, usually mergers cause stock prices to go up, so if you, knowing that a merger is going to take place, go out and buy a lot of stock from both company ABC, and XYZ, you are using insider information, and are breaking the law.
SEC rules and regulations not only pertain to companies on the Exchange, but to the brokers that trade, and to you, the investor. As an investor, you too, cannot buy stocks knowing information about a company that know one else knows. Brokers get the heaviest burden of rules and regulations from the SEC. Most of these rules are to protect you, the investor. An example of one of these rules is that when a floor broker goes to buy a stock on your behalf , he must buy from the lowest priced bidder, and when he is selling, he must sell it to the highest price bidder. Sounds like common sense, but in fact it is not. Floor brokers, could easily sell your stock really low to another broker, in exchange for them selling you a different stock really cheap, to give a better customer a better price. This would not be fair to you, being sacrificed to give another person a better price.
You were right to follow your hunch with McDonald's. Your 250 dollars has skyrocketed into 1000 dollars over a few years. Well, you've been checking the stock price recently and today, when you go get the newspaper, the headline reads "CRASH!". You read on and discover that the stock market has just dropped around 500 points, not to mention the fact that McDonald's stock value which has been slashed in half. You can't believe it- years of work, all gone, in one day.
Sounds frustrating, but if you were investing in the late 1980s, 1987 to be exact, it would of been true. On October 19, 1987 the stock market plunged 508 points, or 22 percent of the total market value. It was the worst crash, since 1927 which signaled the Great Depression. What brought about this crash, why such a drop in such a little time?
One major reason for the crash was fear. Fear of a correction. Fear of a drop. Fear of being to late to get out. The 1980s had brought large stock increases, people had been making fortunes on the huge surges in the stock market. People began to fear that the market wouldn't be able to go up forever, and eventually it would fall, and create what is called a correction.
The fear began to accumulate around October 15th, when The Wall Street Journal published an article entitled, "Stocks May Face More than a Correction." It voiced fear that a correction would bring on a landslide. People began to listen, and big investment brokers began to worry. The SEC and NYSE listened too. They even talked about closing the market on the 19th when there was worry that the crash would come. Even though they decided to keep the market open, news of a potential collapse was the straw that broke the camel's back. The morning of 1987, began with a quick loss of around 150 points. Although, the market did rebound a little before noon, the landslide had begun, and the market was losing too fast to hold back. Many of the specialists, whose job it is to negotiate the trades between sellers and buyers, were going out of business, because the rules state that they must purchase stocks that cannot be sold. In the end, the market plunged, and after the closing bell rang in the NYSE, there was silence between the brokers. People were speechless, many broke.
Why does the stock market go up and down? Theses fluctuations occur partly because companies make money, or lose money, but it is much more involved than that. A stock is only worth what someone will pay for it. Usually, if a company makes a lot of money, its value rises, because people are willing to pay more for a company's stock if the company is doing well. There are many other factors that affect the value of stocks. One example is interest rates, or the amount of money you have to pay a bank to loan money, or how much it has to pay you to keep your money in their bank. If interest rates are high, stock prices generally go down, because if people can make a decent amount of money, by keeping their money in banks, or buying bonds, they feel like they should not take the risk in the stock market.
Many other factors have an effect on the stock market- for example, the state of the economy. If there is more money floating around, there is more flowing into companies making their prices rise. Yet another factor is time of year, and publicity. Many stocks are seasonal, meaning they do well during certain parts of the year, and worse during others. An example is an ice company, the ones that package ice that you buy at the supermarket.
During the summer, with picnics, and sweltering heat, their product sells well, and thus their stock price goes up; But during the winter, when people are not as interested in a picnic with 20 below temperatures, their price goes down. Publicity has an effect on stock prices. If an article comes out saying that company ABC, has just invented this new type of ice that will revolutionize the industry, odds are their price will increase. Conversely, if an article comes out saying that company ABC's president is a crook, and stole the pension funds, it is a good bet that the price will go down.