For most people, money invested in the stock market is managed usually by a fund manager whether it’s a company-sponsored retirement plan or an individual mutual fund brokerage. However, for some people who wish to be more hands-on, they are more than capable of doing the same research and yielding better returns without fees. However, in order to this, they’ll need to know some key principles for smart investing in the market.
The bid-ask spread is an upper and lower bound price based on the last selling price. It means that if someone wants to do a sell a share, they will have to sell it when the equity is up for purchase at a price slightly lower than the last sale price called a bid. Alternatively, if someone is looking to purchase a share when the order is placed, they will have to ask for a price slightly higher than the last sale price. This is what allows stock prices to fluctuate, based on how many buyers and sellers there are at one time.
It’s important to know when you are invested in a company how many people are actively shorting shares of that company. Brokerages are able to track on a daily basis, how many shares are actually being borrowed at any given time, because when people own equities, their information is on record, and thus will be known if they rented it out to someone else. When short interest is high, it can be concerning because there is a pessimistic sense that the price is heading down for various reasons. Alternatively, a stock may get what’s called a short squeeze which forces those shorting to take losses and bring short interest down.
Bull Market and Bear Market
It’s important when you are trading stocks, to understand the market environment that you are in, and how that impacts stock prices and buying and selling activities. In a bull market, the general economy is considered booming and there’s strong reason to believe that companies will continue to churn out great profits. This gives investors confidence to keep buying shares, which generally correlates with uncontested upward movement of stock prices. Alternatively, a bear market could signal either a correction, recession, or depression, signaling economic troubles for companies, that makes investors wary of purchasing equities, thus triggering downward price movement.
In the market, there are two main types of stock transactions that can occur. One is a market order and the other is a limit order. In a market order, you request a guarantee of a stock purchase and, thus, you are willing to purchase at whatever the current price would be. Alternatively, a limit order is one where you set the price that you wish to purchase or sell equity shares and anticipate the share price hitting a threshold that will trigger those transactions. A buy limit order will occur when you expect the price to drop below your buy price and will trigger a purchase at such a price. Alternatively, a sell limit order will occur when you expect the price to rise above your sell price.
Volatility is a critical component of the stock market because it resembles how much a price can fluctuate over time. Volatility is measured through various metrics, that can signal what to expect with your portfolio values when invested in these stocks. Volatile stocks are ones where investors have very sensitive thesis’s on companies and hold a shorter leash to stocks that don’t perform. Volatility also invites traders who are trying to ride quick price swings up and down and thus can contribute more so to volatility.
Liquidity is an important term to note the health of a stock market. It represents money that is in brokerage accounts or mutual funds but is not invested in any equities, but rather just cash so-called sitting on the sidelines. When there is a lot of liquidity, that can mean either a bearish concern and managers get defensive pulling out of stocks, or a market is in fact healthy and a sign of the beginning of a bull market, because investors have a lot of ammo to move up stock prices.