How to Understand the Stock Market

The Stock Market started over a hundred years ago when Mr. Dow and Mr. Jones realized that every company could offer shares of itself to the public for sale. As a company prospered, so would the public that owned shares of its stock.

There are, obviously, many companies. But a good barometer of the overall market would be a few very large and stable companies which would indicate how most companies were doing simply by how the few were doing.

This small group of 30 companies, thirty major industries of the United States, was named in honor of Mr. Dow and Mr. Jones as the Dow Jones Industrial Average, the DJIA.

Often referred to as "The DOW," or "Dow Jones," these thirty companies are such well-known names as MacDonald's, General Electric, Disney, etc. To own stock in these companies, you would buy shares from the New York Stock Exchange, the NYSE. You wouldn't have to go to New York, of course. You'd simply tell your stockbroker to buy 100 shares of MCD or 15 shares of GE or 12,000 shares of DIS, for example.

Such an abbreviation would serve as a symbol and made more sense than spelling out the whole company name. That would take up too much space on the ticker. In the early days, you'd have a little machine that fed out a constant tape-sized paper stream of the changing stock prices. The machine would make an audible "tick" as the tape emerged from the machine ... tick ... tick ... tick ... and you'd see what price was now being quoted for GE ... 62.50, or GM ... 77.25, etc. ... all from the convenience of your stock ticker.

If you couldn't afford a stock ticker, you could read your stock quotes right from the business section of the newspaper. Nowadays, it's easy to have a stock ticker right on your computer, and you can even customize it to show only the stocks you want to see ... those in your portfolio.

In the early days, and even now, the NYSE was a madhouse of activity as buyers and sellers would shout their requests from the trading floor, complete with verifying hand signals. Many decades after the NYSE began, certain newer companies chose to be listed on a new sort of stock exchange, where there would be no buyers and sellers shouting from an "open pit" such as the NYSE.

This newer stock exchange would simply take buy and sell orders over the phone or other means and automatically display the current stock price quotes. Thus, a more sensible approach was born, with the National Association of Securities Dealers, Automated Quotient (NASDAQ).

Unlike the two-letter abbreviation of GE or the three-letter symbol of MCD, those on the NASDAQ use four-letter symbols, such as INTC (Intel Corporation) or AAPL (Apple Computer) or YHOO (Yahoo). Our third stock exchange is the AMEX (American Exchange), and their symbols are in three letters, such as AZC (Azco Mining) and FKL (Franklin Capital). You'll see these stock symbols and thousands more in the business section, and you'll see them on the internet.

So, why should anyone invest in the stock market? Because history shows that the stock market earns more money than that in a bank account or in Certificates of Deposit (CD's) or Money Market Funds, or Government Treasury Bills (T-Bills). Occasionally, as in 1980, when interest rates were over ten percent, it's wiser to have your money in a bank than in the stock market. But that period didn't last long. By 1982, it was time to get out of the bank and back into the stock market again.

Most of the time, the interest you earn in a bank account is very small. In 2005, it was only about one percent. If you'd invested $1000 in a bank, you'd have had ten dollars profit at the end of a year. But if you'd put that $1000 in the stock market, you'd likely have had at least $40 profit (a 4% return) ... and maybe as much as $300 (a 30% return).

Indeed, history shows that stocks earn an average 11% per year, even despite periods like 1929 or 1962 or 1974 or 1987. Plus, there was one period, from 1999 to 2003, when stocks had their biggest "Bull" run in history ... five straight years of 30% gains each year ... an amazing time for investors. There are times, of course, when the stock market seems more like a sleeping Bear than a charging Bull, and your portfolio of stocks falls in value as stock prices fall.

Sure, it's a gamble, much like a bet in Las Vegas. But America's companies don't usually go out of business. While some do, most well-known names and others with equally strong market presence will continue through good times and bad, earning that steady average of 11% per year.

When times are good for the market, the painless way to invest is simply to put your money in a fund that covers the entire market - for instance, the Vanguard Total Stock Market Index (VTSMX). Or, to bank on the largest companies only, buy the Standard & Poor's index of 500 stocks, better known as Spyders (Amex: SPY), Standard & Poor's Depositary Receipts. Other index funds also invest in market sectors such as MDY (for Mid-Caps), DIA (known as "Diamonds" - of the DowJones Industrial Average), and many others. These index funds are traded on the stock exchange just like a share of stock and are thus known by the convenient acronym : ETFs (exchange-traded funds). a complete list and performance comparison can be found at many internet sites such as www.Morningstar.com, for example.

Good times for the market will also urge a bet on the Technology (Tech) sector, with focus on computers and related companies. That would be the NASDAQ 100 (AMEX: QQQ) or other similar funds. And, if you feel the market is DEFINITELY going to go up tomorrow, buy a beta-leveraged fund such as Potomac Over The Counter Index Plus (POTCX) or Profunds Ultra Bull (ULPIX) or Profunds Ultra OTC (UOPIX). If you think the market is going to go down tomorrow, buy a leveraged bear-market fund, such as Profunds Ultra Bear (URPIX) or Ultra Short OTC Inv (USPIX), or Potomac Ultra OTC Short (POTSX), and you'll make money when others are losing.

Stockbrokers used to charge a lot of money to buy or sell stocks for you. With the advent of the internet, and fierce competition between them, you can now trade stocks much easier and cheaper than ever before. Go to a broker like Charles Schwab; it'll cost you a few thousand to open an account and you'll pay $30 per trade (buy or sell). The cheapest is, probably, Scottrade, which charges only $7. Simply go to a Scottrade office (they're all over), give them a check for $500, and you can begin trading stocks from the comfort of your own home, right on your computer (www.scottrade.com).

If you'd like to practice a little, first, for free, go to a site called www.SmartMoney.com and try out a few portfolios to see how they do. The main thing is, to get started taking charge of your finances, making your own decisions about your own investments and your own future, and learning how to earn more money than any bank account could ever earn you.