The Sharemarket : Sharing the wealth

Shares close up

Share market : for some people it is a frightening term,  for others it offers a way to compound wealth and build a future.  Yet what is the sharemarket and why is it so complicated to understand?  Let’s break it down: sharemarket 101 if you will.

Put simply, the sharemarket provides companies with access to capital in exchange for giving investors a slice of ownership in the company.

The sharemarket is a cornerstone of the free market economy and in good economic times, profits are shared between an organisation and its investors.

The price you pay

The market is determined by the price people are willing to pay for particular stocks. This is determined by two things: earnings per share and a valuation multiple. Earnings per share means a portion of a company’s profit that is allocated to each outstanding share of common stock. This indicates profitability. The valuation multiple is a valuation ratio of a company’s current share price compared to its per-share earnings. A full description of these requires an article of its own.

Fundamentally, when you purchase stock, your investment is a proportional share of an entire future stream of earnings and is the price you are willing to pay for those earnings.

Understanding risk

Market factors including economic downturn, global insecurity, and company instability including talk of merger or management restructure and even industry performance can have influential consequences on a share price and therefore profit.

There are ways to minimize your risk, most significantly through some smart asset allocation, which means diversifying your portfolio into a range of different investment vehicles, however the more successful investors understand the risks, know what they are willing to lose and invest accordingly.

Bull and bear

Further comprehension of the stock market will bring you to the terms bull and bear. Don’t mistake these descriptors for a folk music band; these two words in fact, describe market sentiment.

In a bull market the stock market is strong, share prices are rising and investor confidence is high. There are several factors that determine the bull market including economic recovery, boom times and investor optimism.

The bear market offers the opposite point of view: a weak market in which stock prices are falling, investor confidence is low, an economy is in recession, unemployment is high and prices are rising.

While it may sound like you should steer clear of the bear market, it does actually present great opportunities for investors to snap up shares in companies that will no doubt make a strong recovery.

Ways to trade

Shares of publicly held companies are traded through exchanges, more commonly known as the stock exchange, or over the counter (OTC) markets. In Australia, the Australian Securities Exchange guides the market. Other exchanges include the New York Stock Exchange, London Stock Exchange Group and NASDAQ.

Over the counter markets are run by companies that facilitate your trading. Dealers act as market makers by quoting prices at which they will buy and sell a security or currency on your behalf. Traders looking to enter the market should carefully research who they would like to represent them and make themselves aware of costs, regulations and product offering.

If you are looking at entering the sharemarket, you need to understand why you pay what you pay for a stock, whether it is undervalued or overvalued and what companies best suit your trading goals. Once you understand this, measure the risk. The fundamentals are paramount to successful trading and smart investment will help you compound your wealth.

Jonathan Jackson is an experienced editor and writer who has worked in print and digital media for almost 20 years.

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