Investing Basics

This is the first real “lesson” video where we’ll go over some investing basics.

What is a Stock?

A stock represents a share of ownership in a company. When you buy shares of a company’s stock, you are purchasing a small piece of that company. The more shares you buy, the larger your ownership stake.

We’ve all seen shows like Shark Tank and Dragons’ Den where entrepreneurs pitch their company ideas to investors. The investors (the “sharks”) provide money to the company in exchange for equity or ownership. This is similar to what happens when a company sells shares of its stock – it raises money while giving up ownership.

Public companies sell their stock on exchanges so that anyone can purchase shares. As an investor, you’re buying a piece of that company with the hope that it will grow in value over time. Then the stock price will go up and you can sell your shares for a profit.

Some key advantages of owning a company’s stock:

• Voting rights: As a shareholder, you have a vote on certain corporate decisions like electing the board of directors. Of course, regular investors like us have a tiny fraction of the total voting power. But in theory you could help choose the CEO of Apple if you owned shares!
• Claim on assets/earnings: You own a portion of the company’s assets, brand, intellectual property, real estate, etc. You also have a claim on a portion of the profits in the form of dividends.
• Liquidity: Perhaps most importantly, the stock market provides instant liquidity. You can buy and sell shares immediately during market hours. This gives you flexibility as an investor to take profits or cut losses.

Stock Exchanges

Stocks are bought and sold on exchanges like the New York Stock Exchange (NYSE) or NASDAQ. Some key terms:

Order entry platform: This is the software you use to place trades. I’ll be using Trade Ideas and Jessica will use a simulated platform to practice.

Broker: The broker acts as the middleman to facilitate trading. They handle all the backend work like settlement and clearing. My broker is Interactive Brokers.

Stock exchange: This is the market where buyers and sellers are matched. The NYSE is where you’ll find older, more established companies. NASDAQ features tech and growth stocks. The exchange manages the actual buy and sell transactions.

Stock ticker: This is the unique trading symbol of each company (ex: AAPL for Apple). It allows you to pull up the stock’s trading activity.

When you enter a trade through your platform, it routes the order to your brokerage account. The broker then submits your order to the exchange where it can be matched with a buyer or seller on the opposite side. They handle all the back office work and regulatory requirements so that you can seamlessly execute trades.

How Stock Exchanges Work

Understanding how bids, asks and order types function is crucial for new traders.

The stock price you always see quoted (the last trade price) is just one part of the story. The market is really made up of the bid and ask prices:

Bid price: The highest price a buyer is willing to pay for a stock
Ask price: The lowest price a seller is willing to accept

The bid-ask spread is the difference between these two prices.

This Level 2 screen shows the bid and ask prices across multiple exchanges. Look at the total size – this is the number of shares they are looking to buy or sell at that price. The combined size gives you an idea of the liquidity and demand on each side.

The market is constantly moving so quotes are changing rapidly. But at any given moment, the bid and ask represent the current prices that buyers and sellers are willing to transact at.

For example:

Bid Price: $10.00, Ask Price: $10.05

If you want to immediately buy this stock, you will pay the lowest ask price of $10.05. If you want to immediately sell the stock, you will receive the highest bid price of $10.00.

The trading action happens when a buyer (bid) and seller (ask) match up and agree on a price typically in the middle of the spread.

Understanding this concept of the spread between the bid and ask prices is so important. Never assume you can buy or sell a stock at the last traded price you see quoted. Use the bid and ask to enter and exit positions properly.

Order Types

There are a few main order types to understand:

Market Order: This buys or sells a stock immediately at the current market price. Use this when you want to enter or exit a position as fast as possible.

Limit Order: This sets a maximum price you’re willing to pay for a buy order, or a minimum price you’re willing to receive for a sell order. It guarantees that you don’t exceed those limits.

Stop Order: Triggers a buy or sell order when the price hits a certain “stop” level that you define. Useful for protecting against losses.

We’ll dive deeper into orders later when we start paper trading. But getting familiar with how bids, asks and order types function is crucial before you put real money on the line!

PDT Rule

One important rule for small accounts to be aware of is the PDT (pattern day trader) rule. This states that if your account is under $25,000, you can only make 3 day trades (buying and selling a stock within the same trading day) in a 5 day period. Going over this limit results in your account being flagged as a PDT account, which restricts your ability to day trade unless you deposit over $25k. As a beginner trader starting with a small account, make sure you are aware of and follow the PDT rule. Consider swing trading strategies that hold positions overnight rather than active day trading.

Hope you enjoyed this overview of some investing basics. Let me know if you have any other questions before we jump into the next lesson! And be sure to follow along with Jessica’s channel where she’ll document her trading journey from the beginning.