11 Concepts to Grasp Before Investing in Stocks
Investing in stocks can be difficult, and before you hand over any money there are some basic concepts you need to understand. Don’t participate in the stock market until you grasp these 11 concepts.
1. Bull Market and Bear Market
These terms come from the way these two predators attack their opponents. Bulls thrust their horns upward, while a bear will swipe its paws down. With the stock markets, this terminology is used to refer to the movement of the market. A “bull market” is when a trend is on the rise while a “bear market” is on the downswing.
When you purchase shares of stock, you’re buying ownership of a company. There are two ways a stock is sold: long and short. Buying long means the price is expected to rise, and short is when the price is projected to decrease. With short selling, the stock being sold isn’t owned by the seller (usually a broker) but is promised to you (the buyer) at a later date. The shares are then sold, and the proceeds are credited to your brokerage account. Eventually, you must close the short sale by buying back the same number of shares and returning them to the broker. If the price drops, you can purchase the shares at the lower price and make a profit. If it rises, you have to buy it back at the higher price, and you lose money.
3. Growth Stock
With a growth stock, also called glamor stock, the shares of a company are expected to grow at a rate faster than the speed of the market. These stocks do not pay dividends, usually because the company prefers to reinvest in other projects. A growth stock is often considered overvalued.
4. Value Stock
A value stock is a stock that is considered undervalued. Being undervalued means it will trade at a lower price. Value stocks are often associated with new companies or those that have had some problem that calls into question their long-term prospects, making their stock price lower relative to the company’s dividends, earnings, and sales. These stocks are generally purchased because the buyer believes they will increase in value in the future.
5. Stocks and Bonds
A bond is a debt, whereas a stock is an equity. By purchasing a stock, or equity, an investor then owns part of a company. Being a shareholder comes with voting rights and the right to future profits. With a bond, the investor becomes a creditor. The investor has a higher claim to shareholders but no voting rights and will not share profits with shareholders.
6. Dovish and Hawkish
These terms are used to explain where lending rates may lead. These views are referred to as dovish or hawkish. A dovish view means lending rates are dropping and banks are charging less interest than previously. Recently, the Federal Reserve has been in favor of a dovish point of view. A hawkish view is one where the Federal Reserve is in favor of raising interest rates. Stock investments have seen a dovish view by the Federal Reserve for the last six years.
7. Inflation and Deflation
The easiest way to view these terms is by looking at something we’re all familiar with—gas. When gas prices go up, there is inflation, and when the prices go down, there is deflation. These terms are used to explain the increase or decrease in the price of goods. Falling prices cause people to purchase more while increasing prices cause people to sell.
8. Record Date
A record date, or “date of record,” is the final date that a security can be sold. After the record date, a company will determine which shareholders have a right to the dividends or distribution. The ex-dividend and record dates are closely linked, as the ex-dividend date is two days after the record date.
Ex-dividend is the period between the announcement and payment of a security. This term may also be referred to as an “ex-date” or an “ex-dividend date.” At the ex-dividend date, the security remains with the seller no matter who currently owns the stock. According to Investopedia, “After the ex-date has been declared, the stock will usually drop in price by the amount of the expected dividend.”
10. Date of Payment
Date of payment is exactly what it sounds like—the date when a dividend is paid to its shareholders. To receive any payment, you should purchase a dividend at least three days before the record date.
11. Risk and Reward
Calculating risk and reward is a difficult task. Investing requires risk, and the more the risk, the higher the reward. Risk and reward are objective calculations of whether or not an investment will pay off, often shown in ratios such as 2-to-1. It’s important to be conservative while investing—it’s easy to lose large sums of money quickly.