With savings accounts and GICs earning little to no interest on your money at the moment, many people are looking toward the stock market as a place to invest their hard earned cash for a decent return.
But what exactly is the stock market? And how does it work in the most basic way?
And most importantly, how can you get started investing in stocks and bonds?
Here’s everything beginner investors need to know.
What is the stock market?
The stock market is a term for a collection of markets and exchanges where the buying, selling, and issuing of company shares takes place for publicly traded companies.
People can buy and sell pieces of companies, known as stocks or shares, through an institutional exchange. Each country typically has multiple stock exchanges or indices with publicly traded companies listed who do business within their borders.
What’s a stock?
Stocks or shares are simply pieces of a company offered to investors through these exchanges. The stock represents a claim on what the company owns and the profits it makes.
There are a limited number of shares or stocks the company has on the exchanges and the buying and selling of these stocks is what sends the prices up or down.
So why does a company issue stocks? The answer is simply to raise capital in order to turn their short and long term goals into a reality.
Types of stocks
There are different types of stocks you can hold and they fall into 2 main categories:
- common stocks, and
- preferred stocks.
Common stocks are what we typically think of when it comes to buying shares in a company. These stocks generally are voting shares, meaning stockholders have a say in the companies themselves. The more shares you have, the more say you have in how the company is run.
There can be different levels of common shares. Usually called A, B, and C, depending on the company.
One example of this is Berkshire Hathaway, who have both A and B common shares (BRK-A and BRK-B) and the price difference is astounding. Class A shares command about US$350,550 per share while Class B shares are US$233 per share (both accessed February 2 2021 at 15:51 Eastern Time).
Preferred stocks on the other hand typically don’t give voting rights (or only limited voting), BUT they do have a first dibs claim on the distribution of profits over common stockholders.
This means they receive dividends first and have a claim on the distribution of assets if the company is ever liquidated. In a way, preferred stock functions like a hybrid between a common stock and a bond.
But there’s a catch…preferred stocks can be a riskier investment over common shares.
What’s a stock exchange?
As touched on previously, a stock exchange is the place where stocks are bought and sold. In Canada we have 6, with the first 2 being the most popular:
- Toronto Stock Exchange (TSX),
- TSX Venture Exchange,
- Canadian Securities Exchange,
- Montreal Exchange,
- NASDAQ Canada, and
- Aequitas Neo Exchange.
This is where shares in some of Canada’s largest companies are bought and sold.
How do stock markets work?
The simplest way to think about how the stock market works is to know that markets have buyers and sellers. These buyers and sellers determine the price of a stock through demand and the exchanging of buying and selling through an online and/or licensed broker.
The idea behind all of it is that both buying a stock and selling a stock involves risk (and reward) and each of the parties need to agree upon the price their risk is worth.
For the seller, they risk the stock going up after they sell and losing money in the future. For the buyer it’s the opposite effect, they risk buying high and selling the stock at a much lower price later on.
But first, a company must list shares in order for people to purchase and sell. Once these shares are issued, only then is a company’s value realized.
Stock market indices
Stock market indices are specific places where you can buy and sell stocks.
In Canada, the most well-known is the Toronto Stock Exchange, where Canada’s largest companies reside. Everyone from Shopify, to Blackberry, to Thomson Reuters are listed there.
But of course there are many other indices. In fact, it’s estimated that there are 3.3 million stock market indices around the world, with 5,000 in the USA alone.
Overall, people – including money managers – use these indices as benchmarks or indicators for reporting the performance of stocks within them. Of course, we tend to focus on the bigger stock market indices, including the DOW Jones and S&P 500 which have had some serious gains over the past year.
S&P 500
The S&P 500 is short for The Standard & Poor’s 500 Index, which is the 500 largest most influential companies in the United States. These 500 companies are chosen by committee and companies are listed or delisted from time-to-time. We just witnessed one of those moments recently when Tesla took over the position of Apartment Investment and Management Co at the end of December 2020.
So what’s the idea behind the S&P 500?
Many believe the rises and falls of this index give a broad picture of the US market as a whole. When the S&P rises, the total US market seems to rise. When it falls, so does the rest of the US market.
DOW Jones Industrial Average (DJIA)
The Dow Jones is one of the oldest indices in North America (created in 1896) and tracks just the top 30 largest companies in the United States.
If the S&P gives us a snapshot into the US markets, the DJIA has a more razor focused approach to those top companies.
Another aspect this index focuses on is dividends, which are earnings given to investors based on a per-share ratio.
DAX Performance Index
This is the German equivalent of the DOW Jones, tracking the top 30 German companies trading on the Frankfurt Exchange.
This index is worth noting because it’s one of Europe’s largest and most influential – and they’re expanding it by 10 companies this year to 40. Most countries have this type of benchmark for their top companies.
Stock market sectors
To shift gears slightly, each stock market index is composed of sectors. These sectors are typically identified for diversification reasons for an investors portfolio.
It follows the saying to not keep all your eggs in one basket… well it’s not good to have all your money in one area of the stock market.
Below are a few of the different sectors stocks can fall under.
1. Energy sector
This is an exciting and diverse sector in which to invest your money, and the stocks within it can range from oil and gas companies, to hydroelectric companies.
2. Materials
Stocks that fall under materials include anything that is made or fabricated – from concrete, to paper, to metal, and chemical companies.
Materials are the foundation of many national economies.
3. Industrials
Industrials are best thought of as machinery or equipment made for construction and manufacturing.
4. Utilities
Utilities include companies that provide electricity, natural gas, water, sewage, and other services to homes and businesses. These are the sorts of things that you get monthly or quarterly bills for, which would be tricky to live without.
5. Healthcare
Exactly what you think, this sector’s focus is on the well-being of society with a focus on the front line of healthcare to the research and development of pharmaceuticals.
6. Financials
Financials are the banks, but can also be insurance companies (many of which now have banking in their services).
7. Consumer discretionary
Consumer discretionary includes the non-essential things in life, from cars to entertainment.
Think of it as things people can actually live without but don’t want to. Like those season tickets to the local hockey team or symphony.
8. Consumer staples
Consumer staples on the other hand are the stuff in life people can’t live without.
Here think of food and beverages being the main focus – and not your Netflix subscription (which falls under discretionary).
9. Information technology
The information technology sector is also known as tech stocks. These include stocks such as Apple or Spotify, to name a few.
10. Communication services
Communication services are stocks with a focus specifically on transmitting information from one point to the next. This can be cell phone companies as well internet service providers.
11. Real estate
Real estate is another stock market sector that receives plenty of attention these days. These include larger real estate ventures in the stock exchange.
Some of these focus on retail real estate, while others on apartment rentals. Usually they’re under the umbrella of a REIT or Real Estate Investment Trust.
Stock market prices
At the basic level, supply and demand for shares is what determines stock prices.
There can be many other factors to consider (the share price of GameStop being one of those cases). Overall, it’s investors who determine a company’s share price, based on their expectations for that company, essentially speculating about what lays ahead for that company.
There are more forces at work here, but for the most part people are hedging their bets that a company is worth a certain value and they are willing to buy or sell shares in the company for a price.
Stock market volatility
Stock prices are always in flux with buying and selling.
Whenever demand goes up, prices swing upward. When demand is down, so goes the price.
This volatility is what scares away many investors, but selecting companies with solid track records and buying them at value prices makes investors less scared of this volatility.
Common stock market terms
There are some stock market terms that get thrown around a lot by the media and it’s helpful to know exactly what they mean.
Bull market
A bull market is when share prices are rising and continuing to do so, causing investors to keep buying.
The technical definition is when the stock market rises 20% after two declines of 20% each. The interesting thing is that bull markets tend to last for months or even years at a time.
Bear market
A bear market is the opposite of a bull market – when prices decline, encouraging more shareholders to sell their shares.
Stock market crash
A stock market crash is defined by a sharp decrease in stock prices, sometimes due to a catastrophic event or bubble.
It’s sometimes followed by a bear market, but recently we witnessed a crash followed by a bull market following the Coronavirus stock crash.
How to invest in stocks in Canada
The best and simplest way to invest in stocks in Canada is through a discount online broker. And in Canada we’re lucky to have a plethora of choices.
It’s good to understand which suits your needs best. Most notably, for investors starting out, take a look and understand any fees that these brokers charge in order for you to use their services.
Using a discount broker
There are many online brokers out there, below are few who offer competitive fees and diverse account selections.
Of course, choosing a trading account that’s right for you depends on whether you’re using it for retirement savings or for your business.
| Online broker | Cost per trade (stocks and ETFs) | Accounts available | Interested? |
|---|---|---|---|
| Questrade | * Stocks: 1 cent per share * ETFs: Free to buy, 1 cent to sell * Min: $4.95, max: $9.95 | Almost all types of investment accounts, including: * RRSP, spousal RRSP * Locked-in retirement account * Locked-in RRSP * RIF, LIF * RESP, family RESP * TFSA * Non registered accounts * Corporate, investment club, partnership, sole proprietorship * Trust accounts * Margin accounts | Learn more |
| Wealthsimple Trade | * Stocks: N/A * ETFs: Free to buy and sell | * Personal * TFSA * RRSP | Learn more |
Using a financial advisor
For some people, jumping in feet first and creating an online trading account without the knowledge of how it all works can be intimidating. And no doubt, you’ve worked hard for your money and may need sound advice of what to do with it next.
In these cases, speaking with a financial advisor first can really work in your favour.
The best scenario is finding a fee-only advisor, meaning they charge a rate for their advice but you don’t have to open an investment account through them.
These types of fees can be tax deductible, so be sure to save your receipt and claim the expense on your income tax when it comes to tax season.
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The idea of investing money in the stock market can seem like it’s something beyond your grasp, but right now it has never been more accessible through online brokers.
Are you considering becoming a DIY investor?
Or maybe you want to try an online broker offering the services of robo investing.
What’s motivating you to do it? Or, what do you find intimidating and holding you back?
Let us know in the comments below.
FAQ
What is the stock market?
The stock market is a collection of exchanges and indices where shares in a company are bought and sold.
What’s the Canadian stock market?
The Canadian stock market comprises 6 indices with the largest and most established companies listed on the Toronto Stock Exchange.
How are stock market prices calculated?
In the most basic sense, stock prices are tied to buyers and sellers and what a share can be bought and sold for.
What’s a stock market index?
A stock market index is a listing of companies where their shares can be bought and sold.
What’s a stock market sector?
A stock market sector is a grouping of companies who offer similar services or products. These sectors are good to consider when deciding how to diversify the types of companies bought in an investment portfolio.
Should I invest in stocks?
Investing in stocks is an entirely personal decision as it is in no way guaranteed that stock prices will go up. Because of that, there’s a lot of risk involved with buying and selling stocks.
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