Trading Education — Stocks Trading

Investing Basics and Stock Ownership
Stocks, also known as "equity securities" or "equities," represent ownership in a company and a claim against the company's assets and earnings; stocks also represent voting rights in matters presented by the Board of Directors to shareholders for a vote. Stockholders also elect the Board of Directors at the annual meeting or by proxy. Common stock, which represents the vast majority of traded equities, have the lowest priority claim on a company’s assets; the stockholder’s chances of collecting anything in the event of the company going bankrupt are minimal, since creditors and bondholders have a superior claim and will collect first. On the positive side, the shareholder is not liable for any of the debt or possible misdeeds of the company. Investors buy stocks mainly in the expectation of capital appreciation—which may or may not occur. Historical returns have shown that equities eventually outperform other investments such as bonds and precious metals. For many years, stock ownership meant that an investor would receive a physical stock certificate, but in the digital world brokers keep the document "in street name" and investors receive a confirmation of ownership. It becomes the broker’s responsibility to notify shareholders of corporate events, such as annual meetings.

Capital Gains & Dividends
Common stock provides it owner two sources of returns: dividends and capital gains. As discussed above, corporations pay dividends (usually quarterly and in cash) as a way of distributing the company’s profits among the owners. Common stock can provide a second type of income or returns in the form of capital gains when the stockholder sells shares that have appreciated in price since he or she bought them. If you sell shares of stock for a higher price than you paid to acquire them, you earn a capital gain; if you sell shares for a lower price than you paid, you suffer a capital loss. Note, however, that to realize a capital gain or loss you have to sell your stock. If you hold the shares forever, you will receive only dividends per share. Another important issue to note is that currently tax rates differ for income from capital gains and for dividends. If your ordinary income tax bracket is greater than 15%, capital gains on assets held for a year or less are taxed at your ordinary income tax rate (anywhere from 28% to 39.6%, depending on your specific ordinary tax rate). Dividends are also taxed at your ordinary income tax rate, but capital gains on assets held for more than one year are taxed at a reduced tax rate of 20%.

Financial Concepts

• Risk/Return
  The concept of the risk/return trade-off states that potential return rises with an increase in risk. Low levels of uncertainty (low risk) are associated with low potential returns, while high levels of uncertainty (high risk) are associated with high potential returns. For example, the expected return of common stock should be higher than that of "risk-free" Treasury bonds, thoughthis return will be more volatile. Because of the risk-return tradeoff, you must be aware of your personal risk tolerance when choosing investments for your portfolio. Taking on some risk is the price of achieving returns; if you want to make money, you can't cut out all risk. However, the goal is to find an appropriate balance?one that generates some profit but still allows you to sleep at night.
  
  Risk in common stocks is generally measured by "beta," which compares the volatility of a single stock to that of a market index, such as the S&P 500 Index. For instance, if a stock moves with the same volatility of the market (if the index rises or falls 1%, the stock acts similarly), its beta is said to be 1.0. A more volatile stock will have a beta of greater than 1.0, and a less volatile stock will have a beta of less than one.
  
  
• Diversification & Asset Allocation
  Asset allocation is the practice of investing portions of an overall portfolio in different investment categories such as stocks, bonds, mutual funds, real estate, and cash. The theory is that the investor can lessen risk (generally measured by a portfolio’s volatility) because each asset class has a different correlation, or performance characteristics, relative to the others. At times, certain assets are increasing in value when others fall; so the benefit comes from offsetting performances.
  
  The amount of an investor’s total portfolio placed into each class is determined by an asset allocation model, depending on the personal goals and risk tolerance of the investor. Furthermore, individual asset classes can be sub-divided into sectors (for example, if the asset allocation model calls for 40% of the total portfolio to be invested in stocks, the investor might allocate different percentages of this amount to big-cap stocks, technology companies, and/or international companies). This technique is known as diversification, a risk-management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.
  
  Studies by economists and financial theorists have shown that maintaining a well-diversified portfolio of 25 to 30 stocks will yield the most cost-effective amount of risk reduction. Investing in more securities will still yield further diversification benefits, albeit at a significantly smaller rate. Further diversification benefits can be gained by investing in foreign securities because they tend be less closely correlated to domestic investments. For example, an economic downturn in the U.S. economy may not affect the European economy in the same way. Therefore, having investments in European shares would allow an investor to have a small cushion of protection against losses due to an American economic downturn.
  
  Most individual investors have a limited investment budget and may find it difficult to create an adequately diversified portfolio. This fact alone may explain why Exchange Traded Funds (ETFs) are increasingly more popular. Buying shares in an ETF enables investors to purchase a "basket" of stocks with one trade.
  
  
• Dollar Cost Averaging
  Dollar-cost averaging refers to an investment program that contributes the same amount of money each month (or week, or quarter) into an investment, such as a stock or a mutual fund. The main benefit of this program is that, although equity markets generally rise over time, there are fluctuations that often scare investors out of making investments when stocks are at their lowest levels. When you invest a set amount every month, your money will buy more shares at lower prices and less when the market is high. The built-in discipline of this strategy is attractive to many investors who do not have time to track the market closely.
  
  
• Tracking the Markets through Stock Indices
  Securities exchanges and independent data providers, such as Standard and Poor’s Corp, calculate the overall performance of a selected number of stocks in indices. Although the indices do not trade, they are important gauges of market performance and are broadly used for stock analysis and portfolio tracking. They also support popular exchange-traded funds (ETFs), securities that track all the components of the index but trade like a single stock.
  
  The most prestigious and widely-reported index is the Dow Jones Industrial Average, an average of 30 large-capitalization stocks traded on the NYSE and Nasdaq. The technology-heavy Nasdaq 100 Index, launched in 1985, includes 100 of the largest non-financial domestic companies listed on the Nasdaq stock market. The ticker symbol for the Nasdaq-100 Trust is QQQQ, which is an ETF that tracks the Nasdaq-100 and is one of the world’s most liquid securities.
  
  The S&P 500, designed by Standard and Poor’s, is one of the best benchmarks for large-cap stocks. The performance of the S&P 500 is considered one of the best overall indicators of market performance, and many asset managers compare their portfolio’s performance to this benchmark. The ETF that tracks the S&P 500 is known as the "Spider," and trades under the symbol SPY.
  

Reading a Stock Quotation
Below you can see a stock quote for General Motors (GM) from the Zecco Quotes & Research Page.

The Process of Investing in Stocks

• Establishing a Brokerage Account
  
  
  • General Investment Account
    The most common type of brokerage account, this allows an investor to trade stocks and options, and, in some cases, bonds and mutual Funds. The use of margin and options trading features are available with this type of account. Interest is paid on cash balances and charged on margin balances.
    
    
  • IRA Account
    An Individual Retirement Account (IRA) is a tax-advantaged account for individuals. Although contributions to an IRA are limited to $4,000 for tax year 2006, these contributions may be tax-deductible, and your earnings on these investments are not taxed until you begin to withdraw the funds. Click here for more information.
    
    
  • Roth IRA Account
    Similar to an IRA, the Roth IRA, is a tax-advantaged account with slightly different features. Contributions to a Roth IRA are not tax-deductible, but, subject to certain limitations. investment earnings and withdrawals are tax-free. Click here for more information.
    
    
  • Rollover IRA Account
    If you have received a distribution from an employer-sponsored retirement plan, you can invest these funds in a Rollover IRA without paying taxes or penalties. Click here for more information.
    
    
    
• The Trading Process for Individuals
  The most common way investors buy stock in publicly-traded companies is through an account established with a brokerage firm such as Zecco. A brokerage firm is a dealer of stocks and other securitiesand acts as your agent when you want to buy or sell stocks (a broker acts as an agent for another party, while a dealer trades for his own account?most brokerage firms act in both of these capacities.
  
  Most trading of stocks takes place on a stock exchange, a gathering of buyers and sellers for the purpose of buying and selling stocks. The best known stock exchanges are the New York Stock Exchange, the American Stock Exchange, and the Nasdaq stock market. There are also regional stock exchanges in Los Angeles, Philadelphia, Boston, Cincinnati, and Chicago. Some small companies are listed only on a regional exchange, while some NYSE and AMEX companies are listed on these smaller exchanges, as well, to facilitate faster and cheaper trading for investors. Where an investor’s order will trade is largely unknown in the electronic age, since broker’s are obligated to obtain the highest available price for an investor wanting to sell, and the lowest available price for an investor to buy.
  
  When most people think of a stock exchange, they recall images from CNBC that capture a frantic environment with traders in brightly colored jackets shouting incomprehensible commands, making strange hand signals, and throwing paper on the floor. However, behind this seeming disorder and chaos there is a well-organized system of trading that determines stock prices through supply and demand and provides the mechanism to trade billions of dollars in securities each day. Specialists and traders literally create "the market" by continuously updating the prices at which they will buy and sell stocks. As an individual, buying and selling stocks is pretty simple. If you use a full-service brokerage firm, just call them up on the phone and place an order, say, to buy 100 shares of General Motors (GM). Within a few minutes you'll receive a confirmation that your order has been completed, and you'll be the proud new owner of General Motors's stock. Behind the scenes, however, there's a great deal of action that takes place between your order and the confirmation. Here's what has to happen.
  

1. You place the order with your broker to buy 100 shares of General Motors (GM) at the market or at a limit price (the most you will pay on a per share basis).
2. The broker sends the order to the firm's order department, usually electronically.
3. The order department sends the order to the firm's desk on the floor of the exchange where shares of General Motors are traded (the New York Stock Exchange).
4. The firm’s desk clerk gives the order to the firm's floor trader, who also works on the exchange floor.
5. The floor trader goes to the specialist's post for General Motors and finds another floor trader who is willing to sell shares of General Motors.
6. The traders agree on a price, and the order is executed.
7. The floor trader reports the trade to the clerk and the order department.
8. The order department confirms the order with the broker. 
9. The broker confirms the trade with you.

That's how a traditional stock exchange works, but much of the action that takes place when you buy or sell a stock is now being handled electronically.Actuallly, the majority of trades on all U.S. Exchanges take place electronically. So even if you bought a stock that trades on a stock exchange, your order may be executed with little or no intervention by humans. You can log on to Zecco’s website, enter an order, have the trade be executed, and receive a confirmation all within sixty seconds or less. 
 

• Order Types
   
  • GOOD-TILL
    Good-till-date, good-till-time, good-till-canceled remain valid orders until a specific timeframe or customer’s decision to cancel.
    
    
  • LIMIT
    An order to buy or sell shares at a certain price. If the order cannot be filled immediately, the order will remain in effect for the time period the investor has specified (day order, good-till-canceled, etc.).
    
    
  • MARKET
    An order to buy a security at the best price available at the time. Market-on-open and market-on-close are market orders at the start and the end of the trading day.
    
    
  • STOP
    An order to be executed at the best market price available when a certain price level has been reached. For example, you could enter an order to buy 100 shares of XYZ Corp. at $85, stop. The stock must be trading below that level currently, but if it reaches $85, the stop order will buy 100 shares at the market price. A stop-limit order is to be executed at a specific price, not the market-price, once the stop has been reached. Stop-loss orders trigger the selling of a stock when a share price falls below a specific level, and trailing stops set a new stop price in response to the stock’s fluctuation.
     
     
• Buying on Margin
  If an investor wishes to borrow money from his broker to buy a stock, he must open a margin account with his broker, sign a related agreement and abide by the applicable margin requirements. Most standard brokerage accounts include these forms and features automatically. The Federal Reserve Board and self-regulatory organizations (SROs), such as the New York Stock Exchange and FINRA, have clear rules regarding margin trading. In the United States, the Fed’s Regulation T allows investors to borrow up to 50 percent of the price of the securities to be purchased on margin for the "initial margin.
  
  In addition, once investors have started buying a stock on margin, the NYSE and FINRA require them to keep a minimum amount of equity in the margin account. These rules require investors to have at least 25 percent of the total market value of the securities they own in their margin account, meaning that their leveraging power is four times the balance in the account. This is the "maintenance requirement." For market participants identified as day traders, the maintenance requirement is $25,000. When the balance in the margin account falls below the maintenance requirement, the broker can issue a margin call requiring the investor to send more cash or it can liquidate the position.
  
  
  
• Selling Short
  Investors who buy a stock believing its price will rise are said to be "long" on the stock. Those who believe the stock price will go down can "short" the stock by selling the stock, even though they don’t currently own it, by promising that they will deliver it at some point. This is made possible because customers borrow the stock they want to short from their brokers, the margin account of other clients at the same brokerage firm or from a thirdy-party lender. Because it is a loan, some brokers pay the short-seller an interest rate on the short balance. If the short-seller does not borrow the securities in time to make delivery within the three-day settlement period, it is a "naked" short sale. These positions are subject to being covered at any time by the brokerage firm through an open-market purchase.
  
  
• Exchange Traded Funds (ETFs)
  ETFs are securities that track an index and represent a basket of stocks such as an index fund, yet trade like a stock on an exchange. ETFs provide the diversification of an index fund as well as the ability to sell short, buy on margin and the costs related to owning ETFs are lower than the average mutual fund. The best known ETFs are the SPDR [Spider] and QQQQ [Cubes], which track the performance of the S&P 500 index and the Nasdaq-100 Trust, respectively.