Why trade Stocks? Here is a brief guide on the basics of stocks trading.
What are Stocks?
Arguably, the most common and traditional means of investing in financial markets is through common stock, otherwise known as cash equities. Unlike the highly structured and diverse futures and options market, stocks retain a level of simplicity like no other asset in financial markets.
Much like spread betting and CFD products, stocks are also over-the-counter however you're actually buying and selling the underlying asset – in the case of equities, that makes you an owner of the company's share. The stocks market is where companies raise cash by selling shares of ownership through initial public offerings to list on a stock exchange.
By selling equity, companies offer financial investors an opportunity to trade their shares through intermediaries known as brokers and dealers. Buy, sell or hold; three of the most popular expressions on the trading floors across the world and more importantly, are literal in every sense of the word. Stocks can be purchased as long-term investments or traded for short-term profits, depending of the type of investor.
Why consider Stocks?
Stocks are also some of the most liquid investments out there due to their popularity which raises their demand - this means that they can readily be bought or sold at a fair price.
For many, the liquidity of stocks has led to the outperformance of asset versus that of gold over the past year as demonstrated by the outperformance of the Standard & Poor's 500 Index over precious commodity gold.
Capital appreciation versus income
As every stock buyer and holder is a partial owner of a company, the rise in the company's growth means the owners get some share of the earnings - this is called capital appreciation which is the end-goal for any investor seeking long-term growth.
Source: Bloomberg chart: S&P500 versus Gold over 12-months
Dividends yields and reinvestment
Dividend payments are cash rewards given to shareholders as part of the profit made by the company at the end of each financial year. Dividends are declared at the company's annual general meeting. The larger the units of your shareholding, the more money you receive at the end of each financial year. To find out how much a company pays out in dividends each year relative to its share prices, the yield is a measure of how much cash flow you receive from a stock.
Mature, well-established companies tend to have higher dividend yields, while young, growth-oriented companies tend to have lower yields or none at all as they may not be paying out dividends. Dividend rewards can be optimised further by reinvesting in dividends – this means using the proceeds of each dividend payout to purchase additional shares of the stock which will then attract dividend payments in the future as well as capital growth on the shares.
Overvalued, undervalued and fairly-valued
Due to the nature of fluctuating stock prices, the market is crammed with overvalued and undervalued stocks with the fairly-valued ones in-between them. The undeniable favourites are undervalued stocks where the market price is too low for its fundamentals, presenting an opportunity for buyers to pick-up the stock cheaply. By contrast, overvalued describes a stock for which the market price is considered too high for its fundamentals, leaving the stock vulnerable to profit-taking.
For both overvalued and undervalued stocks, the market's valuation of the stock is based on the share price not justified by the company's financial status, fundamentals earnings and growth potential. To calculate the underlying value of a stock, investors tend to use a simple price to earnings ratio often referred to as the PE ratio. This ratio is calculated by dividing the price by the earnings per share (EPS).
On average, the market PE ratio is 15, so a stock with a PE ratio less than 15 is considered undervalued and a PE ratio higher than 15 is considered overvalued. The tougher part is finding a fairly valued stock whose current trading price accurately reflects its actual value. Most investors historically have used a company's earnings power as a measure of its value. If earnings are strong, and going up, there's a good chance that the stock price will too.
Stock markets are cyclical – they go up, peak, go down and bottom. Once the cycle is over, another starts. Whether it's a bullish or bearish market or one in which central banks have fuelled the market with stimulus and loose monetary policies or, conversely, through monetary tightening by cutting stimulus and raising interest rates, these environments change the profile of cash equities from attractive to unattractive.
Typically, in a cycle where stock prices go up steadily, one would describe it as a bull market while one that falls steadily will be classed as a bear market. When prices reach a bottom, traders see the market as a cheap and deem cash equities as attractive. By the same merit, when prices peak, traders see the market as expensive and deem cash equities as unattractive – these cycles can last for a few weeks or months.
Why trade Stocks with Saxo Capital Markets?
- Access 19,000 global Stocks across 36 exchanges
- Active Trader price plans available, with commission fees from £5*
- Ability to hold multiple currency sub accounts
- Free Stock transfers**
* To qualify for the Active Trader Pricing Plan, you need to execute at least 100 trades per calendar month on Stocks, ETFs and Single Stock CFDs.
**Transfer fees from previous suppliers may still apply.
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