Investment Basics (Part I) - Equity Market

The purpose of this post is to share with you on the means of investing. On this particular post I will only touch on the equity market and what are the options available, along with the risk. For those who wants to know more feel free to contact me, as I am currently conducting some weekly basic trading lesson for some of my friends.

Stocks/Shares 

Definition

In business and finance, a share (also referred to as equity share) of stock means a share of ownership in a corporation (company).

When you buy stock in a corporation, you become one of its owners. If the company does well, you may receive part of its profits as dividends and see the price of your stock increase. But if the stock price falls, the value of your investment can drop, sometimes substantially.

A stock has no absolute value. At any given time, its value depends on whether its shareholders want to hold it or sell it, and on what other investors are willing to pay for it. If the stock is hot, and lots of people want shares, the price may go up. If a company is losing money or a particular industry is doing poorly, those stocks may drop in value. Some stocks are undervalued, which means they sell for less than analysts think they're worth, while others may be overvalued.

Investors' attitudes are determined by several factors: whether or not they expect to make money with the stock, by current stock market conditions, and the overall state of the economy.

Types of Stock

Stock typically takes the form of shares of either common stock or preferred stock. As a unit of ownership, common stock typically carries voting rights that can be exercised in corporate decisions. Preferred stock differs from common stock in that it typically does not carry voting rights but is legally entitled to receive a certain level of dividend payments before any dividends can be issued to other shareholders.

Buying Stocks

Though you probably use the term broker to describe all the professionals who buy and sell stocks, the financial markets use titles to describe more precisely the ways securities change hands.

Brokers handle buy and sell orders placed by individual and institutional clients. They may earn a commission on each transaction or receive an annual fee based on the value of the client's account.

Dealers buy and sell securities for their own or their firm's account, helping to keep the market liquid. Dealers make their money on the difference between what they pay to buy a security and the price they can get for selling it.

Traders, also called registered or competitive traders, buy and sell securities for their own portfolios. The term trader also describes those employees of broker-dealers who handle the firms' securities trading.

Usually you buy or sell stock in multiples of 100 shares, called a round lot. But in some countries (e.g. United States) you can buy just a single share, or any number you can afford. That's called an odd lot. Brokers at one time charged you more to buy and sell odd lot orders. But now these orders are handled electronically, without additional charge.

Value movement

“A stock's value can change at any moment, depending on market conditions, investor perceptions, or a host of other issues.”

The price of a stock fluctuates fundamentally due to the theory of supply and demand. A stock doesn't have a fixed price, or value. When investors are buying the stock, the price tends to go up. But if they think the company's outlook is poor, or if the overall market is weak, they either don't invest or sell shares they already own. Then the price of the stock tends to fall.

But price is only one way to measure a stock's value. Return on investment — the amount you earn by owning the stock — is another. To assess return, you add any increase or decrease in price from the time of purchase and any dividends the stock has paid over that time. Then you divide by the amount you invested to find percent return. As a final step, you can find the annualized return by dividing the return by the number of years you owned the stock.

The stock market goes through cycles, heading up for a time, and then correcting itself by reversing and heading down. A rising period is known as a bull market — bulls being the market optimists who drive prices up. A bear market is a falling market, where stock prices fall by 20% or more and may remain depressed. Overall, the market has tended to rise higher following a fall. But bear markets can take a big bite out of your portfolio's value in the short term. 

Derivatives

Derivatives are financial contracts, or financial instruments, whose values are derived from the value of something else (known as the underlying). The underlying on which a derivative is based can be an asset (e.g., commodities, equities (stocks), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) — see inflation derivatives), or other items (e.g., weather conditions, or other derivatives). Credit derivatives are based on loans, bonds or other forms of credit.

The most common type of derivatives being used are: futures and options.

Options

An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, such as a piece of property, or shares of stock or some other underlying security, such as, among others, a futures contract. In return for granting the option, the seller collects a payment (premium) from the buyer.

Call Option

In the case of an equity option, a contract that gives the buyer the right, but not the obligation, to purchase a set amount of stock (usually 100 shares) at a predetermined price anytime before the contract expires (American Style option) or at expiration only (European Style Option). The predetermined price is known as the strike price.

Put Option

In the case of an equity option, a contract that gives the holder the right, but not the obligation, to sell a stock at a set price for limited period of time. The seller or writer of the option is obligated to buy the stock at the strike price in the event that the option is assigned.

 

	Holder (Buyer)	Writer (Seller)
Call Option	Right to buy	Obligation to sell
Put Option	Right to sell	Obligation to buy

 

Futures

What are Futures?

A futures contract is the obligation to receive or deliver a commodity or financial instrument at a specific date in the future at an agreed upon price today.

These contracts have the following standard specifications:

1.     Underlying instrument

The commodity, financial instrument, or index upon which the item is based.

2.     Size

The amount of the underlying item covered by the contract.

3.     Delivery or contract cycle

The specified months for which contracts can be traded.

4.     Maturity date

The date by which all particular futures trading month ceases to exist and all obligations must be fulfilled.

5.     Grade/quality specification and delivery locations

A detailed description of the commodity or security and where, when, and how it can be delivered.

6.     Settlement procedures

Rules for physical delivery of the underlying item, including how payments are made and received, or the specific cash series and procedures used for cash settlement of the contract.

These contracts are traded on an organized and regulated futures exchange enabling buyers and sellers to transact business. In most cases, traders fulfill the obligation of the contract by taking the offsetting position. For example, if a trader is long a futures contract, he must sell the contract prior to the expiration date to avoid taking delivery of the physical commodity.

 

Futures and Options Distinctions

While both futures and options are derivative products, they have their differences in terms of obligations.

	Options	Futures
Buyer	Has the right to buy or sell the underlying security	Has the obligation to take delivery of the underlying commodity or financial instrument on expiration at the settlement price.
Seller	Has the obligation to buy or sell the underlying security	Has the obligation to make delivery of the underlying commodity or financial instrument on expiration at the settlement price.

 

Traders that hold futures position always have the obligation to buy or sell the underlying commodity. In order to meet this obligation, traders need to offset the futures position.

In most equity markets, 1 Options Contract gives the right to buy and sell 100 shares while 1 Future Contract normally involves 1000 shares. Thus, options are more affordable to most people as compared to futures.

Leveraged  Trading

Stock that a trader does not actually own may be traded using short selling; margin buying may be used to purchase stock with borrowed funds; or, derivatives may be used to control large blocks of stocks for a much smaller amount of money than would be required by outright purchase or sale. Be cautious that this type of trading involves higher risk and may result in the loss of the initial amount. Not advised for amateur traders.

Short selling

In short selling, the trader borrows stock (usually from his brokerage which holds its clients' shares or its own shares on account to lend to short sellers) then sells it on the market, hoping for the price to fall. The trader eventually buys back the stock, making money if the price fell in the meantime or losing money if it rose. Exiting a short position by buying back the stock is called "covering a short position." This strategy may also be used by unscrupulous traders to artificially lower the price of a stock. Hence most markets either prevent short selling or place restrictions on when and how a short sale can occur. The practice of naked shorting is illegal in most (but not all) stock markets.

Margin buying

In margin buying, the trader borrows money (at interest) to buy a stock and hopes for it to rise. Most industrialized countries have regulations that require that if the borrowing is based on collateral from other stocks the trader owns outright, it can be a maximum of a certain percentage of those other stocks' value.

 

Contract for Difference (CFD)

Another example of leveraged trading is CFD. A contract for difference (or CFD) is a contract between two parties, typically described as "buyer" and "seller", stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. (If the difference is negative, then the buyer pays instead to the seller.) For example, when applied to equities, such a contract is an equity derivative that allows investors to speculate on share price movements, without the need for ownership of the underlying shares

Contracts for difference allow investors to take long or short positions, and unlike futures contracts has no fixed expiry date, standardized contract or contract size. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 30% of the notional value for CFDs on leading equities.

Currency or Forex Trading

Is another form of trading which capitalize on the the movement of the exchange rate between base currency and quote currency (often mentioned as currency pair). The aim is to earn the difference by converting between the 2 currencies at different timing. Often the currency pair being used are US Dollar (USD) and the local currency, depending on the location of the trader.  Another way is to trade using major currency pair. The Majors are: EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD and USD/CAD.

There are also a few derivatives used in forex trading, but I won't go in depth on the subject.

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"The only way to have plenty of money is to learn how to handle the money"

How "Not Thinking" Can Do Us Good

The title may sound a bit weird. Since young, we have been taught to think, plan, and analyze every single factor before we decide to do anything. 

Being able to analyze and plan before we do anything is a good thing, but sometimes for many people this kind of habit might become a hindrance. 

Many of us are experts in analyzing and planning, but not all of us are able to take action.

Over thinking things might leave to procrastination, which is the biggest obstacle to success for most of us. 

Personally I'm struggling to overcome this problem. There are many opportunities available out there, but I have not been able to fully utilize them due to one single reason. I tend to think to much. 

In alphabet, S is located between R and T. So is SUCCESS, which is somewhere between being RECKLESS and THINKING too much. 

Result = Plan x Action 

If an action is not well planned, it will result in nothing. Same thing happens to people who plan properly but never take any actions.

The question now is "how to prevent this from happening?"

Arrange a goal and a timeline

Meaning that we must try to set a specific goal and how long will it take for us to do it.

The goal must be something achievable.  By setting up a specific goal, it can provide us with the extra motivation that we may need to immediately take action.

Second danger that may arise from thinking too much is fear.

Some people tends to be pessimistic when they are facing conditions where they are not too familiar with. This pessimism creates fear. Fear is something natural, meaning that every single living person may feel this when they are facing the unknown. Great people are those who can view the "unknown" as opportunity. 

This kind of people possess the mental strength and the optimism to be able to step out of their comfort zone and embrace the unknown. Mental strength refers to how much stress you can handle and tolerate. While optimism refers to how you view things.

Mental strength is naturally different from one and another. But even for those with weaker mentality, there is still a solution, which is by accumulating experience. We may not be able to control what will happen to us, but we can control how we will react. By continuously pushing ourselves to the limit and always try our best, we can actually train up our mental strength.

For my case, by learning to take rejections and disappointment, I have slowly build up my tolerance to failure. 

Optimism is a state of mind. Being optimistic means being able to see the silver lining in every single black cloud that we may face. 

Many amazing success stories out there tells us that simply by being positive, we can reallyovercome everything that comes along our way.

~~~Success is 35% Ideas, 60% Sweat, and 5% Luck~~~

Note: By writing this stuff, I tend to learn more things about myself and the direction I should take. Currently struggling to motivate myself more and more every single day. >_<

"AFTER 6 PM" Rule

Most of us are working or planning to work in a company. As we all know, in a company we received a thing called "salary". For most of you, you are receiving a fixed amount of money every month. (unless you are receiving a commission based pay structure>> like me). Meaning that the company is the one who decides how much are you going to be paid. 

So when we mention about being successful and earning more than other people can earn, it can't be done simply by sitting down and work every single day. 

That's where the "After 6 PM" rule comes to play. 

After 6 PM rule basically mentions that how successful we can be, all depends on what we do after 6 PM (after our normal working hour). If we simply follow the normal path, it's hard to be extremely successful. Climbing the corporate ladder takes decades, and it also requires the person above us to move away from his/her seat. 

Meaning that most of the billionaires out there did not build their wealth by working for someone else. I'm not saying that it is wrong to work for your company. It is good to learn through the corporate way, but the final goal should always be to start something on our own.

The second reason to apply the After 6 PM rule is the illusion of job security. Some people feels that they are safe working in a company, but this recession is a wake up call for many. Many of my friends who were very comfortable working in a corporate line have just experienced what is called retrenchment. There are no such thing as job security as long as we are still working for other people. That is the reason why we should do things to create a true security for ourselves.

Now the question is how to apply After 6 PM rule ?

Before that, we should know how rich people make their money. 

There are 2 main paths in reaching financial stability.

1. Business>> Basically a sustainable business which gives constant stream of income. This is how rich people acquire their wealth from. 

Business = Opportunity (Creative Ideas) +  Skill + Resource + Trustworthy Partner

Trustworthy partner is an optional. Most of us who wants to start a business from nothing sometimes requires a partner to work together with. Meaning that we dont have to be able to do everything from A-Z. We just have to find a brilliant idea and outsource the right people to assist us to start something.

2. Investment>> This part is a bit tricky, in the sense that for some people, investment is a powerful money generating tool. For others, it is a place where you place your money in, and nothing comes out. 

Bottom line, lack of knowledge can kill you.

Investment can be divided into 3 main types.

A. Equities Market (Not suitable for moody and easily stressed people)

Equities is a double edged sword. Meaning it can help you or kill you. It comprises of shares, derivatives, commodities trading, etc. Be careful not to play in the equity market with minimum knowledge.

B. Properties (Location.. Location.. Location..)

Property is something that is used by the world richest people in growing their wealth. Although most of them requires big amount of money to be invested in, some are actually quite affordable such as Land Banking and REITS.

  

C. Exotic Investments (Quite interesting to learn about these)

Some of you might have heard of these few "unique" investments such as wine investment, stamp collection, old currencies collection, etc.

After knowing what the rich are doing, the next thing to do is to find the things that we can start doing during our "After 6 PM" time.

Few suggestions based on what I've seen and learn from people and what I'm currently doing:

1. Trading (Equities Market) 

Trading is a skill. It is hard to master, but once we have mastered it, it can provide us with sustainable income. Meaning that even if you're retrenched, you won't go hungry. Furthermore the equities market is something that will never go bankrupt or close down.  

Note that trading is different than investing. Trading refers to a way to make money in a shorter time line, from a few minutes to months. (Depends on the type of trading we are doing) 

2. Internet Marketing

Internet marketing is a growing trend. There are a few ways in doing internet marketing. The main ways are these 2. SEO and PPC.

SEO-> Search Engine Optimization

PPC-> Pay per Click

Internet Marketing is quite similar to trading. Meaning that it requires time to polish up the skill, but it can generate a sustainable income for you.

3. Exploring Side-Line Business

Side-line business refers to doing extra work in a job field other than your main job. In return commission is usually given out to them. For instance, some people are working full time and also act as a property agent during weekends to earn extra bucks. Or in my case, there are few people working under me in bringing prospective clients to me.

4. Doing Proper Investment

In Investing, few things to note is to first Identify your Risk Appetite, remind yourself Not to be Greedy. Learn about the investment tool. Know about the Risk and Opportunity before you decided to go in. Know how to put the "Eggs" in different baskets.  Feel free to ask me as I'm working in this line. =)

5. Starting a Business

The last and the most important one. This should be something that is embedded in our mind. Opening our mind and thinking out of the box is a crucial step in looking for a good opportunities and ideas to start our business. Strong businessman can immediately spot opportunities that comes along their way. The way to train this is to open up our perspective by reading or learning as much as possible from people who has managed to make it big.

Out of the 5 points above, number 1 to 3 is Optional. Meaning that only do it if you have any interest on the particular subject. 

For instance me, I have been intensively learning about trading for the past few months. After getting the necessary skill and information, I started doing paper trading for 2 months before I finally trade with actual money. But for internet marketing wise, i am not doing it. The concept is interesting, but I have no passion in pursuing it seriously.

No 4 and 5 on the other hand is something that needs to be done for all of us. Proper investment is necessary in order to grow our wealth. Why work hard for money when we can make our money work for us? And as I have mentioned earlier, starting a business should be made into our goal. Don't get too comfortable in our comfort zone and miss out all the great opportunities out there.