Stock Basics Tutorial

Turn on the TV news or open a newspaper, surf the internet or listen to the radio, and you will probably come across some information about the stock market: “The Dow Jones closed at record highs”; “The S&P 500 is trading down two-tenths of one percent”; “The stock market is reacting to news from Washington.” The stock market seems to be everywhere in our daily lives, but what exactly is the stock market? And, what are stocks that are bought and sold on this market? What does it mean for you, for your employer, or for your country’s economy when the stock market had “a good day”?

The answers to these questions are not always obvious once we begin to think about what stocks are.  For example, you may have heard that owning stock means that you become an owner of that company. But what does that mean? As an "owner" can you rightfully walk into one of its offices and take home a chair or a desk? Can you hire and fire people? Of course, if you only own a small number of shares, you only “own” a small percentage of the company – but what if you own a majority of the shares, could you then take home a chair or fire workers?

In this tutorial, we will answer these questions and more, often going into some depth to explain core concepts. Once you’ve come to grasp these concepts and understand what makes the stock market tick, the hope is that you’ll become a smarter, more informed, and savvy investor. Even if you don’t have a brokerage account of your own and invest with your own money, you may very well be exposed to stocks via your 401(k) retirement account, pension plan, college savings plans, health savings plans, or insurance policies. Once a tool for the rich, the stock market has now turned into the vehicle of choice for growing wealth for many segments of the population. Advances in trading technology and low-cost stock brokerage services on the internet have opened up stock markets so that today nearly anybody can own stocks with the click of a mouse.

Before proceeding, however, it is important to distinguish between two common uses of the stock market: investing and speculation. Investing is when you hand over your money so that it is put to use for productive projects such as growth or expansion. Investing in a factory, in research and development, in a new business idea – these are all done with the expectation that in the future, the factory, the research, or the startup will be worth more than the original investment. That means you have a reason to believe the factory needs to be expanded, or that you understand broadly the type of research being done and what the payoff might be, or that you understand and believe in the business plan of the new venture. In other words, investing is a rational decision made with an eye to the future. When you invest, your money is intended to be put to work increasing value.

Speculation, on the other hand, is akin to gambling. Speculators purchase something with the hope that they can soon sell it at a higher price, but without necessarily understanding – or even caring – about why the price should go up. Sometimes, speculators have a gut feeling, or are trading on rumor, but ultimately they do not concern themselves with the factory, the R&D, or the business plan. Speculation should not always be viewed as a bad thing, however; speculators add liquidity to markets, and many have done very well for themselves. At the same time, many smart investors have lost their fortunes in the stock market through speculation. The important distinction between investors and speculators is not a normative one, but rather that investors are generally more interested in the processes underlying prices; they are in it for the long haul, while speculators are more interested in the price itself, and with shorter time horizons for making money.