The Wall Street Journal Complete Money and Investing Guidebook

The Wall Street Journal Complete Money and Investing Guidebook

by Dave Kansas
The Wall Street Journal Complete Money and Investing Guidebook

The Wall Street Journal Complete Money and Investing Guidebook

by Dave Kansas

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Overview

Unravel the Mysteries of the Financial Markets—the Language, the Players, and the Strategies for Success

Understanding money and investing has never been more important than it is today, as many of us are called upon to manage our own retirement planning, college savings funds, and health-care costs. Up-to-date and expertly written, The Wall Street Journal Complete Money and Investing Guidebook provides investors with a simple—but not simplistic—grounding in the world of finance. It breaks down the basics of how money and investing work, explaining:

• What must-have information you need to invest in stocks, bonds, and mutual funds

• How to see through the inscrutable theories and arcane jargon of financial insiders and advisers

• What market players, investing strategies, and money and investing history you should know

• Why individual investors should pay attention to the economy

Written in a clear, engaging style by Dave Kansas, one of America’s top business journalists and editor of The Wall Street Journal Money & Investing section, this straightforward book is full of helpful charts, graphs, and illustrations and is an essential source for novice and experienced investors alike.

Get your financial life in order with help from The Wall Street Journal.



Look for:

• The Wall Street Journal Complete Personal Finance Guidebook
• The Wall Street Journal Personal Finance Workbook
• The Wall Street Journal Complete Real Estate Investing Guidebook

Product Details

ISBN-13: 9780307498861
Publisher: Crown Publishing Group
Publication date: 12/08/2010
Series: Wall Street Journal Guidebooks
Sold by: Random House
Format: eBook
Pages: 224
Sales rank: 467,517
File size: 5 MB

About the Author

Dave Kansas is editor of The Wall Street Journal’s Money & Investing section and the author of The Street.com Guide to Smart Investing in the Internet Era. He lives in New York City.

Read an Excerpt

CHAPTER 1

Stocks

Many people have heard of the New York Stock Exchange; maybe some have even seen footage of people scurrying around in strangely colored jackets. But just what are all those people doing at the NYSE, and what does it mean to you as an investor?

First, we should take a step back. Buying and selling stocks involve financial markets. And markets sound more complex than they are. In fact, many of us start learning about markets from a very early age.

As kids, many of us set up lemonade stands. We had a product we wanted to sell, and we went looking for buyers. We needed information to set prices. What were the kids on the next block charging? What kind of demand did we see? The corner of a block seemed to offer more opportunity than

the middle of the block. None of us considered working from the alley. We also needed to know how much our sugar, plastic cups and water cost, in order to see if we were making any money at five cents a cup.

A stock market isn’t that different. It’s about buyers and sellers. It’s about finding a place where the most buyers and sellers are located. It’s about supply and demand. Basically, all the transactions in our life, from selling a used car to running a garage sale, contain elements of what happens among those brightly dressed folks running around the stock exchange floor (by the way, those jackets help traders quickly identify who a fellow trader works for). But in the world of stock markets, things happen faster and on a much larger scale than at a lemonade stand.

TWO TYPES OF MARKETS

In the United States, stocks trade in two main markets: the New York Stock Exchange and the Nasdaq Stock Market. A number of other markets exist, but they make markets mainly in stocks that are primarily traded at one of these two marketplaces. When companies go public, they can seek to list on any of these exchanges.

The New York Stock Exchange

The New York Stock Exchange is the oldest stock market in the United States. It began in 1792 under a buttonwood tree in lower Manhattan, with folks trading shares back and forth among one another. Since then it has grown to become the largest stock market in the world.

It’s now located on the corner of Wall Street and Broad Street in lower Manhattan, but its physical place is less and less important. In a world of high-speed information, stock market participants can work from Whitefish, Montana, as easily as from the floor of the exchange itself.

Trading at the New York Stock Exchange, often called the NYSE or the Big Board, uses a so-called specialist trading system. In this system, a single person is in charge of the trading in a particular stock. For instance, if you want to buy a share of IBM, your bid will ultimately go to the specialist assigned to trade IBM. That specialist acts as a kind of traffic cop, directing movement among buyers and sellers. He or she looks around to find someone who wants to sell a share of IBM at the price you want to buy. The matching up of buyers and sellers occurs throughout the trading day, and sometimes the specialist buys or sells for his own account if an order can’t be matched.

When the NYSE is on television, sometimes you see a gaggle of folks standing in front of the specialist, hollering out buy and sell orders. That’s when the specialist looks most like a traffic cop—pointing, gesturing, yelling. It looks confusing, but it’s just a simple matching up of buyers and sellers so they can trade stocks.

Along with shouting and pointing, specialists also match buyers and sellers electronically. This kind of high-tech activity makes up a growing amount of the trading that happens at the New York Stock Exchange. While the trading volume and the number of stocks trading at the NYSE have grown dramatically in the past twenty years, the number of people working on the floor of the stock exchange has remained about the same, thanks largely to the growth of high-tech, all-electronic trading. All aspects of NYSE trading, including electronic trading, are refereed by the specialists.

The HISTORY OF THE NYSE

The New York Stock Exchange, the world’s largest and best-known stock market, traces its history to 1792, when a group of brokers in our young nation agreed to trade stocks and other securities for a commission (securities being another name for financial assets such as stock and bonds). The Buttonwood Agreement—so named since it was reached under a buttonwood tree in lower Manhattan—initiated trading in five securities, a small start for a market that now lists stocks with a value of about $20 trillion.

In 1817, the group of brokers and traders adopted a set of rules and the name “The New York Stock & Exchange Board.” Over the following decades, the exchange would trim its name but add greatly to the number of stocks traded: banks, insurance companies, canal companies and, as the century rolled forward and America moved westward, rail, mining and steel companies.

The stock market swelled in importance and popularity as the years passed by, helping to finance the growing nation’s infrastructure through projects such as the Transcontinental Railroad and the Erie Canal. But the NYSE became the heart of various financial panics, too. Jay Cooke, who played a role in financing the Union efforts in the Civil War, was a large dealer in the bond market through his eponymous company. In 1873, Jay Cooke & Co. collapsed due to large, bad bets on railroad stocks, forcing the market to close for ten days and triggering a national uproar.

In 1896, The Wall Street Journal published its first Dow Jones Industrial Average (DJIA). It was the first popular measuring stick for the NYSE and remains a cultural touchstone more than a hundred years later. Its initial value was 40.74. The DJIA, a price-weighted average, reached its initial value by totaling the share prices of its twelve component stocks (today it has thirty component stocks) and dividing that figure by a “divisor” to reach the average price. (For more on the DJIA, see page 22.)

In 1903, the NYSE moved into its current location. Three years later, the Dow Jones Industrial Average closed above 100 for the first time.

The stock exchange closed for four and a half months in 1914—its longest closure ever—just before the start of World War I. Concerns about the market’s health amid so much uncertainty, compounded by trading losses ahead of open conflict, led market officials to shut down operations. The NYSE reopened later in the year. After the war ended in 1918, the NYSE became the center of the stock market world, supplanting the London Stock Exchange.

The exchange’s most infamous events occurred in 1929. The Roaring Twenties led to widespread speculation, roaring stock prices and newfound wealth. But the dreams of getting rich on stocks ended badly. On Black Tuesday, October 29, the DJIA fell 11%, to 230 points. The DJIA, which had peaked in September 1929 at 381.17, wouldn’t reach that level again until 1954.

In the wake of the crash, the Great Depression unfolded, and the Securities and Exchange Commission (SEC) was created to police the stock markets. Prior to its establishment, few rules governed the buying and selling of stocks. Politicians believed that the watchdog function of the SEC was needed to restore confidence in the stock market.

But during the Depression, few people cared much for the market. Trading was thin, as the memory of the 1929 crash and the wealth lost remained far too vivid.

In the late 1960s, a steady increase in trading volume led to a paperwork crisis. Eventually, greater automation was adopted to stave off a problem that had back offices processing trades around the clock for months in order to keep up with trading volume.

In 1987, the stock market crashed once more, with the Dow Jones Industrial Average dropping 22% in a single day. NYSE volume topped a then-record 500 million shares, yet the NYSE was able to maintain a relatively orderly market, something that competing markets, such as the Nasdaq Stock Market, failed to do. The following day, as prices stabilized, volume set another record, topping 600 million shares.

By 1990, the stock market had evolved from its clubby beginnings to include wide swaths of America. More than 50 million individuals owned shares of stocks traded on the exchange. This rise of individual investment in stocks continues today.

Daily trading volume passed 1 billion shares in 1997 during a selling panic that prompted officials to halt trading briefly. The downdraft became a blip in an otherwise impressive move in share prices. From 1995 to 2000, the Dow Jones industrials rose from 5000 to 10,000, eventually clipping past 11,000.

But the good times—or the bubble, as many came to see it—didn’t last. Starting in the spring of 2000, major market measures peaked (the DJIA at 11,722.98 and the Nasdaq at 5048.62) and then slid. Over the next few years, the Dow slipped toward 7000 and the Nasdaq Composite Index lost more than half its value, dropping below 2000.

In the wake of the September 11, 2001, attacks, which destroyed the nearby World Trade Center, the NYSE closed for four sessions, its longest closure since 1933. Trading reopened on September 17, with a record 2.37 billion shares traded.

Today, daily trading volume routinely tops 1 billion shares, and about 2,800 stocks trade on the New York Stock Exchange. While trading still takes place via a specialist system established in the late 1800s, most transactions move through the exchange electronically. Listed companies are based all over the world, including in Japan, China, Latin America, Europe and Africa.

The Nasdaq Stock Market

The NYSE has tough listing requirements, so many less-proven companies, especially young technology companies, begin life on the Nasdaq Stock Market. The Nasdaq, known for its high-tech stocks such as Microsoft and Intel, trades in a different way. Rather than having specialists who manage the trading

in specific stocks, the Nasdaq Stock Market relies on an army of so-called market makers to trade stocks. Market makers

are like specialists, in the sense that they focus on the trading of one stock or a specific group of stocks. But rather than a

single referee, the Nasdaq has groups of market makers all making deals in a single stock. These market makers post bid (sell) and ask (buy) prices and trade shares among themselves, usually on behalf of investors.

Interestingly, the Nasdaq Stock Market doesn’t have a floor like the NYSE. Its trading world is all electronic, living in the phone lines and computers of various brokerage firms around the country. Market makers advertise their buy and sell orders through this network; they can see one another’s orders and match buys against sells.

ECNs

Electronic communications networks are the newest way to trade. These all-electronic networks enable buyers and sellers to find one another in a manner similar to the Nasdaq Stock Market, but large investors favor the speed of ECNs. ECNs also often provide for lower transaction costs and a degree of anonymity that is favored by very large investors. Large investors like a bit of shielding so that competitors don’t know their trading moves. If others know a large investor is buying a big chunk of a certain stock, they may want to join the buying fray. More buyers mean more demand, making the stock more expensive for our large investor. By staying anonymous, the large investor can accumulate a large chunk of stock without the trouble of attracting hangers-on.

ECNs trade all sorts of stocks, but various regulatory rules make it easier for ECNs to trade Nasdaq Stock Market stocks than New York Stock Exchange stocks.



INDEXES AND HOW THEY ARE CALCULATED

When most people think about the stock market, one of the first things that comes to mind is the Dow Jones Industrial Average. Newscasts, cocktail party conversations and idle chatter about stocks often revolve around “how the market is doing.” With thousands of stocks trading, “the market” is a slippery notion. But the Dow Jones Industrial Average enables people to take a measure of the market. Often called simply “the Dow,” the industrial average is the most popular such measure.

The Dow has thirty large stocks in it, representing major industries such as finance, technology and retailing. The measure is more than a hundred years old, and of the original group of components only General Electric remains (and even it spent a little time outside the Dow during the past century). The components of the Dow Jones averages are determined by the editors of The Wall Street Journal. The editors make changes to maintain the relevance of the Dow Jones average in relation to the overall market. For instance, as the U.S. economy has evolved away from a manufacturing focus, steel companies have fallen off the Dow industrials. At the same time, technology companies, such as Microsoft and Intel, have been added in recent years.

Other popular measures of the market include the Standard & Poor’s 500-stock index, which tracks the performance of 500 blue-chip stocks, or stocks of companies (including stocks in the Dow Jones Industrial Average) known for their long-established record of earning profits and paying dividends. The Nasdaq Composite Index, wildly popular during the Internet bubble of the late 1990s, measures the performance of all the stocks in the Nasdaq market. The Nasdaq Composite, which includes technology giants such as Microsoft and Cisco Systems, is often seen as a proxy for that important sector. The most popular measure of smaller stocks is the Russell 2000, which tracks the performance of 2,000 small-capitalization stocks. (Capitalization refers to the market value of the company, and that figure is reached by multiplying the share price by the number of shares outstanding.) The Russell 2000 stocks have an average market capitalization (often shortened to simply “market cap”) of about $1 billion. By comparison, stocks in the DJIA often have market caps of many billions of dollars.

As computer technology has advanced, the number of market measures has proliferated. Broad measures, such as the New York Stock Exchange Composite Index and the Wilshire Total Market Index, calculate the performance of large groups of stocks. These indexes provide a more complete measure of how the market is doing. But despite these technological improvements, the thirty-stock Dow remains the most frequently cited gauge of how the stock market is doing.

As mentioned earlier, the Dow is a “price-weighted” average. Here’s how it works. To get a closing figure of the Dow, add up all the price moves of the thirty stocks. If each stock rose by $1, that would come to $30. Then divide that number by the “divisor.” The divisor is determined by the editors of The Wall Street Journal and is published on page C2 of the paper. The divisor has been less than 1 since 1986, and thus it now acts as a multiplier. In mid 2005, the divisor was 0.13033708. Thus, a $30 total would lead to a gain of more than 220 points in the Dow. If each stock lost $1, the calculation would be the same, except that the result would be a loss of more than 220 points.

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