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Investing Basics: Stock, Stock Market, and Stock Market Index

Investing Basics: Stock, Stock Market, and Stock Market Index

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Following the success of Introduction To Morningstar Style Box, I thought it might be a good idea to start writing more introductory level articles about investing. In this introduction to investing in the stock market series of articles, I will attempt to answer three basic questions:

  • What is a stock?
  • What is the stock market?
  • What is a stock market index?
Investing Basics: Stock, Stock Market, and Stock Market Index 1
Photo by thinkpanama via flickr

What is a Stock?

A stock is basically a share of ownership in a corporation. When you buy 1 share of Microsoft you own a tiny fraction of the company (approximately 1/8,400,000,000) — so I really meant it when I said tiny. In other words, to own 1% of Microsoft, you would have to own about 84 million shares, or approximately $2.2 billion worth of Microsoft stocks (as of 4/20/2011).

How Do You Make Money with Stock Ownership

Fundamentally, there are two ways that you can make money in the stock market.

  1. You buy shares of a company and the share price go up because the company is doing well. Later on, you could sell these shares at a higher price and make profit on your initial investment. On the other hand, the company could do poorly and you will end up losing money. Note: this basic explanation does not account for other factors that affect the stock price, such as, economic factors.
  2. Additionally, some companies offer quarterly dividend payments. Dividend is usually expressed in a percentage called Dividend Yield. For example, Microsoft offers a dividend of 16 cents, or a dividend yield of 2.5%. If you own 100 shares of Microsoft, you’ll receive $16 each quarter as the dividend payment.

What is the Stock Market?

Often, we speak of the stock market as if it’s a singular entity that exists somewhere. In fact, there are many physical stock markets, called stock exchanges. Two well-known stock exchanges in the United States are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotation System (NASDAQ).

Investing Basics: Stock, Stock Market, and Stock Market Index 2
Photo by mlmtdotcom via Flickr

Other major stock exchanges include:

You can see a more comprehensive list of major stock exchanges at Wikipedia.

What is a Stock Market Index?

When you hear the newscaster report the “Dow Jones Industrial Average plunged 400 points,” he is referring to what we called a stock market index. There are many stock indices around the world, and the most well-known ones in the United States are:

Investing Basics: Stock, Stock Market, and Stock Market Index 3
Photo by travel aficionado via flickr
  • Dow Jones Industrial Average (DJIA) — This index consists of 30 of the largest and most widely held public companies. It is the most cited and most widely recognized of the stock market indices
  • S&P 500 — This index consists of the 500 largest corporations and is considered the barometer for the U.S. economy. It is most famous for the numerous index funds that are designed to match its performance, leading to indexing revolution of the recent years.
  • NASDAQ Composite — This index consists of all common stocks and securities listed on the NASDAQ stock market. It is considered the key indicator of technology and growth companies performance.

There are many stock market indices from around the world, for example:

I hope this series of articles help you understand the concepts stock, stock market, and stock market index a little better. As a follow up to this article, I’d like to recommend: Practical Investing Guide For Beginners. If you hands on investing is not for you, you can also check out investing for beginners using Betterment.

Reviewed and updated April 20, 2011.

6 thoughts on “Investing Basics: Stock, Stock Market, and Stock Market Index”

  1. Great way to put into perspective with 1 percent of Microsoft. I always wondered how many shares one percent was and had to laugh when I found out here that it was 93 million shares.

    But indeed, purchasing a share means ownership. In a sense, you are taking responsibility for your company’s action which is why we vote at the meetings if we approve or disapprove of the direction the company is heading in.

    Now only if we could vote on the company’s discretionary funds and dividend payouts…

    Looking forward to reading more.

  2. I’ve been looking forward to a series of posts like this for awhile. Looking forward to the rest of the posts! As a beginner, it’s very daunting to try to understand the stock market, especially with just a little bit of income to invest.

  3. Great post and very informative. People just need to remember that investing in the stock market is more like speculating than true investing. Even with dividend paying stocks, you are buying an equity position in a company and equity is only worth what people “think” it is worth.

    Unlike income producing assets or known returns, equities can lose all their value overnight or triple in that same timeframe – based on people’s perceptions. That being said, some equity is entities is less risky than others simply because they have been around longer. But don’t be fooled by this either. GM stock is now trading at levels not seen since the early 1970’s. That means the company has receded in value since then – not grown.

    Great post though to help with the unraveling of what it means to be investing in the stock market.

  4. Great article and introduction. To speak to Kevin’s point above, if you approach stock picking from a value basis, your investing becomes less speculative. Rather, you are looking for stocks that are priced inaccurately low (remember, the stock market is not perfect) given the company fundamentals and growth expectations. Of course, there is always risk, but careful selection with thorough research can minimize this risk. This is a longer-term investment strategy.

  5. @MBL — Yeah, it’s quite humbling to understand what 100 shares of Microsoft really means in the grand scheme of things.

    @Ryan — I am overdue for some sort of “investing guide” that ties everything on the blog together.

    @Kevin — Great point to clarify the risky nature of stock investing.

    @Steve — I agree with value investing strategy — that’s my preference as well.

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