As a new investor in the stock market – and this hold true for many seasoned investors – one of the scariest possible events is a stock market crash. The idea of a crash fills an investors mind with thoughts of large losses, possibly to the point of wiping out some investments. The fear of a crash may prevent you, as a new investor, from participating in the stock market and not allow you to benefit from the long-term accumulation of wealth a well conceived investment plan will produce.

Although the stock market moves in an upward direction over the long term – building wealth for investors in stocks and mutual funds, the market also moves in cycles of positive value gains followed by periods of declining values. The periods of upward price movement are referred to as bull markets. Bull markets in the stock market last from a few years to a decade or longer. A period when stock values are declining is referred to as a bear market. Bear markets are sharp and abrupt compared to bull markets. A stock market crash is the worst type of bear market, when the market loses a significant amount of value in a few days or a few weeks. A market crash is big news and both the financial news sources and the mainstream news outlets will run with the story. The resulting flood of news stories concerning a crash will generate more fear in investors. Many unprepared investors will immediately sell out of their stock market holdings, taking large losses on their investments. Many more will wonder if they should also sell. The bottom line result is that a market crash is a scary event for investors and without a plan and most will probably make the wrong decisions and lose a lot of hard-earned money.

The first thing you as a new investor must understand is that the occasional market crash will occur. The investment strategies you select must take the probability of a crash into consideration. The second point is that crashes occur much less often than the predictions concerning a possible crash would suggest. There is big money to be made from selling doom-and-gloom, market crash predictions. What could be considered market crashes have occurred just three times in the last 40 years. However, in the current investment environment, crashes tend to be on investor minds with two very deep bear markets occurring in the last 12 years. Of those two, one – in 2000 and 2001 – was pretty easy to see coming, but the second – in 2008 – definitely looks like a crash on a long-term stock market chart. The final point a new investor must remember is that the market has always recovered from each crash and moved significantly higher in subsequent years. Arguably the most famous crash in the modern era – the 1987 crash where the market dropped by almost 40 percent in less than a week – is now a hardly visible blip on the long term market chart. The recent 2008 market crash will also look like a blip a couple of decades in the future when your investment portfolio is worth many times the value you have invested.

As an investor, your greatest danger when a stock market crash occurs is giving in to the fear and selling off your stock market investments just after the crash occurs. It takes mental strength to fight the fear and stay with the investment strategies you are using to build long term wealth. A market crash will make it seem as if all of your plans were futile and you have made a big mistake by investing in the market. If you stick to your investment plan, you will get past the crash and your wealth building will continue. In your investment planning, the possibility of a market crash should be included in your timing considerations of when you plan to withdraw money from your investment accounts. For example, if you are building an investment portfolio for retirement, the portion of stock market investments in the portfolio should be reduced as your retirement date approaches. It is not good planning to be 100 percent invested in the stock market if you need money each year from your investments as part of your retirement income.

The best way for you to avoid the “sell it all now!” fears of a stock market crash or lingering bear market is to establish and investing plan which eliminates any timing concerns in the market. One strategy is to use a plan of periodic investments, investing the same amount into your stock index mutual funds every month or every quarter. Another strategy is to set up a firm asset allocation plan and re-balance between stocks and other investments – such as a bond fund – on a regularly scheduled basis. Using a combination of these strategies plus the other information available here on Beginning-Investing-Made-Easy.com will put you far ahead of most individual investors. You will build your wealth with a minimum amount of time spent managing your investments and earn the maximum amount of sleep, without worries about your investment values.

Going up? The Bulls

Here’s the fun part – The bulls, betting the markets going up; the bear betting the market is going down. This is the battle that’s waged every day… And a lot of people profit while they fight it out! Time to get in the game.
Let’s talk about the positive guys – the Bulls
Not exactly the eternal optimists, these are the guys betting up the market. And when times are good, it seems like everyone’s a bull. When the markets on the way up it’s called a bull market. Recently the US (and most of the world) has been riding a nice wave of increased stock prices, this making it easy for those who be up to be right. Not always the case but when you learn how to read the charts most of the time you can hit at about 70% when you’re trading for the term. Some people like to ‘buy and hold’… there’s an inherent risk in this, and that is the market goes up, you’re happy, market goes down you’re sad. More on this later…

Back to reality | The bears – Party killers or reality check?

As we saw with the tech bubble burst, and with the GREAT recession of the later part of the last decade, the US (and most of the world) entered into a ‘bear market’, one in which the market took a down turn. For the knowledgeable trader, this doesn’t mean anything more than instead of trading for the stock price to go up, the trade is made for the stock to go down or ‘short selling’. This is how you make money in the market on the way down! Those who have 401ks would be wise to move their assets to ‘cash’ (meaning to get the money out of the market and sit on the sidelines until the drop bottoms out) instead of watching their net worth plummet! You are going to be smarter than that and capitalize on the downturn by learning the proper strategies.

The Other Animals on the Farm – Chickens and Pigs

Chickens are afraid to lose anything. Their fear overrides their need to make profits and so they turn only to money-market securities or get out of the markets entirely. While it’s true that you should never invest in something over which you lose sleep, you are also guaranteed never to see any return if you avoid the market completely and never take any risk,
The ‘stock’ (not shares)

There are two other types of folks on this farm, a couple of terms which I picked up off of Investopedia.com. Those are the chickens and the pigs; let’s talk about both of them here…

The Chickens

You can probably guess this, the chickens are the ones in the market  who can’t stand to take any losses. Fear is their driver and they lose sleep every night waiting for the ‘inevitable’ downturn, take their money out of the market and severely limit their potential gains. While it makes sense to use good judgment (and get properly educated), making trades you aren’t comfortable with isn’t a good idea to begin with. Trading on fear will most likely end badly.

The Pigs

Ok, to be completely transparent… these are guys who ‘get slaughtered’ (hence the pig term). High risk trades into companies they don’t know much about, making decisions based on emotion and not doing their due diligence are the trademarks of this class. They get the hot stock tip, get greedy, have no patience, ‘bet the farm’ and don’t get the proper knowledge of what they’re doing before making investments. To the delight (and I mean this in the nicest possible way) of the Bulls and Bears, the pigs get slaughtered because they zig when they should zag and the knowledgeable ones on the street get paid off.

Time for you to decide… Who are you going to be?

This isn’t necessary a fair question as you can be playing bear and bull at the same time depending on what investment you’re looking at. However, there’s clearly one type of animal you don’t want to be and that’s the pig! The pigs do not win… As the old saying goes: “Bulls make money, bears make money, but pigs just get slaughtered!” Don’t be a pig. However, don’t be a chicken either! There’s risk in everything we do from the time we wake up in the morning and our feet hit the ground. The right answer here is be educated and actively track what you’re going to invest in.

If you haven’t done so already, get your brokerage account opened up. I’m not suggesting you go make a trade today, but if you don’t have a brokerage account, you can’t get in the game. I suggest again going to etrade, but you can use whoever you like.

Get some knowledge:

There are a couple of vehicles out there to get yourself on the right track, I recommend picking up a couple of things. One is a site for a penny stock trader, this has had a good track record and will allow you to start tracking some stocks which don’t require a lot of capital to start making trades with.

The other is a more advanced technology called Auto Binary Trading, a must have for you if you are ready and have some capital to start making trades.

Thanks again for reading!

Michael

How Does the Stock Market Work

Getting start with Exchanges

So, now you have a general idea of what a stock is, why companies issue them and some of the basics of trading. Let’s move on to where to go to start trading stocks and get going with your own brokerage account! Stocks can be found on ‘exchanges’. This is where traders, both buyers and sellers come together to determine what price shares will be traded at. Some exchanges, such as the NYSE (New York Stock Exchange) are at a physical location while others, such as the Nasdaq, are electronic (or virtual) based. As exciting as it would be to be on the floor of the NYSE, screaming prices and running around making deals, I prefer the electronic version while sitting comfortably in my office. The entire reason for a stock market to exist is to aid in the trading of stocks (securities) worked out by the buyers and sellers. This way there is a risk reduction of the trading of the securities (stocks) by consolidating them into one place. Realistically, a stock market – either the NYSE or the Nasdaq – are a common meeting place for buyers and sellers to hook up to trade stocks. Let’s take a closer look at the different types of markets – these being ‘primary’ and ‘secondary’ markets. What is meant by a primary market is one that handles the initial offering of a stock or IPO (this is covered another blog post). A secondary market handles stocks which are not newly issued, these are the stocks that are truly in the ‘stock market’. At this point it is important to note that when you are trading stocks, you are not trading specifically with the company you are buying or selling, simply that you are working within a marketplace.

A quick history of the major exchanges

NYSE | The New York Stock Exchange

This is probably the most famous of all exchanges, and has been around the longest in the professional sense. Sometimes called the ‘Big Board”, this exchange focuses only on a limited number of the most successful business in the United States. Companies such as 21st Century, Cigna, and Ford Motor Company. The NYSE is based on face-to-face trading, known as a listed exchange. This may seem like an old school way of doing things, but old habits are hard to break. They still employ ‘specialist’ who get the buyers and sellers together and place the orders at the trading posts. Now this is all great information, but not going to help you get started with your own trading because unless you want to fulfill a degree in financial management, we’ll stick online trading (you can still trade these stocks through your online broker… I recommend eTrade)

And in second place…. The Nasdaq

Really made famous by the fantastic technology boom of the late 90’s and early 2000’s, this is an ‘over-the-counter’ (OTC) market. This exists is a virtual market place (there are several others discussed later). All of the trading of securities is done electronically, congratulations on moving into the 21st century! Some of the stocks found on the Nasdaq include Kraft Foods, Intel, Sirius, Cisco, and Comcast. The difference in how stocks are traded on the Nasdaq (unregulated) as compared to the NYSE (regulated) is the Nasdaq depends on a ‘market maker’. This is a person who monitors and provides the ‘bid’ and ‘ask’ prices within a certain tolerance or ‘spread’ for the shares of companies they represent. This person gets the buyers and sellers together and keep a percentage of shares available in their market to ensure availability when traders come looking to make transaction.

And all the others:

There a bunch of other exchanges out there you can check out including a couple of the more notable ones being the the LSE (London Stock Exchange) or the HKSE (Hong Kong Stock Exchange) Now I don’t personally play in those markets, these would be considered FOREX (Foreign stock exchanges), but they can be extremely lucrative (more information on FOREX markets here) The stocks I mainly focus on are Penny Stocks… and why would I do that? Simple answer: a 30% gain is a 30% gain, whether the stock goes from .03 to .039 as it is if it goes from $30 to $39. The point: I can make a whole lot more trades for substantially less money and make the same gains! The risk: there is little to no regulation in these markets. The bottom line always comes down to getting trained and making educated decisions.   Take away: Get your own etrade account set up here Highly suggested: Get up to date tips on penny stocks here For those of you ready to REALLY get serious check out Autobinary trading Thanks for reading and taking action!

RJ, a coworker of mine just finished setting up his first trading account through a discount brokerage and made some initial purchases. When the shares settled a few days later he was a little confused by the different sets of numbers in his account, why they were different and what they meant. He was talking about market value and book value listed at the bottom for his holdings page. Another issue came up before he actually made the initial purchases. While searching and selecting the shares to buy he found common and preferred shares, and some companies had different classes of common shares. He was wondering what it all meant. I gave him the quick version and promised him a post with a more complete answer, so here you go RJ…

Market Value versus Book Value

Your first question is pretty straight forward RJ. Simply put, market value is what your shares are currently worth if you were to sell them on the market today. This will go up and down depending on how the market is doing, and of course over time you are looking for this to consistently increase in value. Book value is what you paid to attain those shares, which includes the price of the shares themselves plus any trading fees and additional costs, and this number will never change for as long as you own them. Let’s say you bought 1 share of Giant Widget Corporation 1 years ago when it was $100. Add in a $5 trading fee, and your book value is $105. Your market value would only be $100 at that time, so initially the book value was higher (I think this is what you noticed, RJ.) Now jump ahead to 1 year later, the book value is still the same at $105, but the stock has gone up in price considerably, and now the market value is somewhere around $200. Looks like it was a good investment.

Year 1
Book Value $105
Market Value $100

Year 2
Book Value $105
Market Value $200

Both numbers are good to keep tabs on in your portfolio and are important for gauging how well your investment is doing. A market value higher than book value shows you’ve made a good choice and made money, while a lower market value than book value means you’ve had a loss. So RJ, if and when you decide to sell you would want your market value as high as possible beyond your book value, showing that you made a profit (or capital gain) on your shares.

Common versus Preferred Shares, and Share Classes

Your second question is a little more complicated. Common shares are your general every day shares, which grant you a partial ownership in a company and voting rights to go along with it. You may receive a portion of the company’s profits through dividends and could see the value of your shares go up or down based on the current market. Preferred shares are a higher level of shares, and receive preferential treatment, hence the name. Preferred shares usually have a fixed dividend pay date, to the point of being considered a fixed income investment, though they may not have voting rights. Preferred shares are traded on the same market with common shares, but will have a slightly different name and symbol, so be careful when you buy. They also tend to have less fluctuation in market price compared to their common brothers.

The common shares are the low man on the priority totem pole, meaning you are the last to get paid. This is not a problem when things are going well and there is more than enough money to go around.  Any dividends or distributions are paid out to preferred share holders first, and common share holders after. But when times are tough you can find the common shares having a dividend cut or even suspended while the preferred shares continue to collect their full amount. If things really go sour and the company goes under, cash gained from liquidating assets goes to creditors and lenders first, followed be preferred share holders, and if there is any left over it will finally make it’s way down to the common share holders. This can be a pretty devastating blow to common share holders, who could be left with a bunch of worthless stocks in a worse case scenario.

Sometimes a company may offer additional classes of common shares as well, often designated by the letters A, B, C, and so on. The most important difference between the classes is their voting rights, with one usually being much higher than the others, counting for 5 or ten times what the lesser shares votes are worth, sometimes even more. For example, class B shares may give you 1 vote per share, while class A shares give you 10 votes per share. Different classes therefore have different share prices on the market. These aren’t the same as preferred shares however, as all common share classes have the same rights to profit distributions.

I hope that clears a few things up for you RJ, and will help you as you continue to build your portfolio. Keep the questions coming, and thanks for the idea for this post.