The stock market

What is the stock market?

The stock market investment objective is simple: buy some units of ownership in a company, hold on to them, watch them go up in value, sell them for more than you paid and make a profit. You don’t have to be a finance expert, but it’s good to understand the basics before you go throwing cash around in an attempt to become a Wall Street tycoon. The stock market is also known as an equity market and involves an exchange between sellers and buyers of shares in an electronic network such as the Australian Securities Exchange (ASX). Stocks that are listed publicly on the ASX can be traded via online brokers. The total market value of shares in the ASX is a staggering $1.7 trillion. There are 6.7 million shareholders who’ve invested in 2224 companies.

So how does it work?

When an investor purchases a share, they buy a very small piece of the company and become a shareholder. Everyone wins here: it helps the company raise equity capital that does not need to be repaid, while the shareholder receives perks such as dividends. That means you cash in when the company profits. Shares can be sold back when the share price is higher than when the investor initially purchased them, resulting in a capital gain.

Other key terms you’ll need to become familiar with include:
All Ordinaries Index: This is the capitalisation-weighted index of performance of share prices of about 500 of the largest Australian companies.
Futures: an agreement to buy or sell an asset on a future date at a price agreed at the time the contract is made.
Hedge: a transaction that offsets the risk of a holding

What do I need to know before I start investing?

Before investing, you’ll want to consider your current financial position, how much money you have to wager, and think about what kind of risks you are comfortable with. But you don’t have to be flush with funds. The stock market can be an accessible place to begin investing even if you don’t have a lot to spend. For example, you can open an individual trade account with your bank for a small service fee, and you’re on your way. You could begin by buying just a handful of shares.

When choosing companies to invest in, it is important to think about how much room for future growth that business has. Do your research and find out what kind of products the companies you want to invest in have in the pipeline, as this could contribute to the company’s success. The potential for future growth is a critical factor in the company’s ability to pay you a solid dividend.

Should I take risks or invest conservatively?

Deakin University Associate Professor Victor Fang suggests avoiding risky stocks if you’re new to investing. But once you’re comfortable with your understanding of the market, investing in some riskier stocks can have its advantages, including the chance of a much higher return on investment. ‘Study company financial statements and do a bit of homework,’ he cautions. ‘A small oil exploration company might be a risky investment, for example. They may drill in the wrong place and find they’ve made a mistake. If they don’t profit, neither do you. But if they drill and find more than they expected their dividends could be much higher than anticipated.’ If you want to play it safe, Assoc. Prof. Fang says you should put your money into blue chip companies that are large enough to provide a stable dividend. That includes companies such as the big four banks and Telstra.

What’s the best way to get started?

There are two ways to purchase shares. The first is to immediately purchase shares from a company as they first go public, which is known as a ’float‘, or Initial Public Offering (IPO). To buy shares this way you must review the company prospectus, fill in your application form and select the number of shares you want to purchase. Depending on the level of interest in the float, you may receive fewer shares than you wanted or none at all.

Alternatively, get a stockbroker or financial adviser to manage your portfolio. They can also advise on the level of risk you should take on. You can establish a client account with a licensed ASX market participant who’ll manage the purchases on your behalf. If you think you’re confident enough to manage your portfolio, you can set up your own online trading account through your bank or other service provider and devise your own investment strategy.

How much money can I make?

That’s a hard question to answer, as return on investment varies greatly depending on an individual’s talent for reading the market and their understanding of trends, fields and individual companies – there’s also an element of luck. As a general rule, share values rise in the long term, although there can be volatile periods from time to time. Those who stick with the market and keep a long-term perspective in mind are more likely to see the success over time.

Global economic woes can have an impact on the market and the value of your shares. Take the ‘Black Monday’ market fall in China, which impacted company share values around the world. The Australian market lost $60 billion in share values due to China’s steep decline – particularly in finance and resources. China’s stock market had grown a huge 120 per cent in the past year, which was not sustainable. When these events occur, the market can sometimes become known as a ‘bear market’. This means there’s enough negative sentiment to trigger a rush of share sales and a downward spiral of share values.

What if the going gets tough?

There’s no denying the fact that there’s been some economic uncertainty in the global market, but Assoc. Prof. Fang says this is inevitable. During these nail-biting times, he suggests looking at ‘safe haven’ investments such as gold when the global market is facing wild swings. He says wise investors diversify well beyond the ASX and consider overseas investments in global markets. Many economists argue that plunges are nothing more than market value corrections and prices will stabalise soon enough. Rises and falls in share prices are an inevitable part of the stock market investment ride.

Further reading: Market rollercoaster isn’t over – Associate Prof Victor Fang in the Herald Sun, July, 2015