As a total beginner, how do I begin to understand finance & stocks?

Question

As the title states, I'm a complete beginner to finance. I haven't had a financial background, by the time I got my first proper job I struggled to understand my wage. I did study engineering and am more than capable with complex mathematics. I want to swim against the current and learn how this economy works, in my pursuit of wealth and freedom.
Now I've been trying to wrap my head around the stock market (jumping in at the deep end?). From 2 days of research I've learned that:

• An investor seeks to buy stocks at a low price, and sell when the price is high.
• Price (of a stock) is affected by supply/demand, volume, and possibly company profits.
• Owning a stock is like owning a tiny chunk of the business, with the legal rights that come with it.
• and assorted chunks of knowledge about support/resistance I won't be able to apply yet.

What I want is for someone, with this in mind, to explain to me the relationship between all different values I would see - we're not even thinking about making real-world predictions or reading graphs yet.
So we have supply, demand, volume, company revenue & profits.
How I understand it is: supply/demand affect price of stock negatively/positively, respectively. Volume is the amount of buying/selling activity in these stocks (more volume = more fluctuation, right?). Company revenue (and profit) will help an investor predict company growth.

Can anyone confirm this for me? And back it up with a few points of your own? All answers (except troll ones) will be absorbed and appreciated!

UPDATE: Thanks to everyone who answered, it's good to see I'm on the right track, according to these answers. I won't be investing anything until I'm totally confident but this has brought me closer. Now I'll be hitting the books, combing the web, and absorbing all this information.

Answer 1

Your understanding of the stock market is absolutely correct theoretically. However there is a lot more to it. A stock on a given day is effected by a lot of factors. These factors could really be anything. For example, if you are buying a stock in an agricultural company and there was no rainfall this year, there is a big chance that your stock will lose value. There is also a chance that a war breaks out tomorrow and due to all the government spending on the war, the economy collapses and effects the prices of stocks.

Why does this happen?

This happens because bad rainfall or war can get people to lose confidence in a stock market. On the other hand GDP growth and low unemployment rates can make people think positive and increase the demand in a stock driving the prices up. The main factor in the stock market is sentiment(How people perceive certain news). This causes a stock to rise or fall even before the event actually happens. (For example:- Weather pundits predicted good rainfall for next year. That news is already known to people, so if the weather pundit was correct, it might not drive the prices up. However, if the rainfall was way better than people expected it to be it would drive the price up and vice versa. These are just examples at a basic level. There are a lot of other factors which determine the price of the stock. The best way to look at it(In my personal opinion) is the way Warren Buffet puts it, i.e. look at the stock as a business and see the potential growth over a long period of time. There will be unexpected events, but in the long run, the business must be profitable. There are various ways to value a company such as Price to earnings ratios, PEG ratios, discounted cash flows and you can also create your own. See what works best for you and record your success/failure ratio before you actually put money in.

Good Luck,

Answer 2

Your questions seek answers to specifics, but I feel that you may need more general help.

There are two things, I feel, that you need to learn about in the general category of personal finance. Your asking questions about investing, but it is not as important, IMHO, as how you manage your day-to-day operations.

For example, you should first learn to budget. In personal finance often times "living on a budget" equates to poor, or low income. That is hardly the case. A budget is a plan on how to spend money. It should be refreshed each and every month and your income should equal your expenses. You might have in your budget a $1200 trip into the city to see a concert, hardly what a low income person should have in theirs.

Secondly you need to be deliberate about debt management. For some, they feel that having a car payment and having student loans are a necessary part of life and argue that paying them off is foolish as you can earn more from investments. Others argue for zero debt. I fall in the later. Using and carrying a balance on high interest CCs and having high leases or car payments are just dumb. They are also easy to wander into unless you are deliberate.

Third you need to prepare for emergencies. Engineers still get laid off and hurt where they are unable to work. They get sued. Having the proper insurance and sufficient reserves in the bank help prevent debt.

Now you can start looking into investments. Start off slow and deliberate with investing. Put some in your company 401K or open some mutual funds on the side. You can read about them and talk with advisers, for free, at Fidelity and Vanguard. Read books from the library.

Most of all don't get caught up in too much hype. Things like Forex, options, life insurance, gold/silver, are not investments. They are tools for sales people to make fat commissions off the ignorant.

You are fortunate in that Engineers are very likely to retire wealthy. They are part of the second largest demographic of first generation rich. The first is small business owners.

To start out I would read Millionaire Next Door and Stop Acting Rich. For a debt free approach to life, check out Financial Peace University (FPU) by Dave Ramsey (video course). His lesson on insurance is excellent.

I am an engineer, and my wife a project manager we found FPU life changing and regretted not getting on board sooner. Along these lines we have had some turmoil, recently, that became little more than an inconvenience because we were prepared.

Answer 3

I think you've got basics, but you may have the order / emphasis a bit wrong. I've changed the order of the things you've learned in to what I think is the most important to understand:

Owning a stock is like owning a tiny chunk of the business

Owning stock is owning a tiny chunk of the business, it's not just "like" it. The "tiny chunks" are called shares, because that is literally what they are, a share of the business. Sometimes shares are also called stocks. The words stock and share are mostly interchangeable, but a single stock normally means your holding of many shares in a business, so if you have 100 shares in 1 company, that's a stock in that company, if you then buy 100 shares in another company, you now own 2 stocks.

An investor seeks to buy stocks at a low price, and sell when the price is high.

Not necessarily. An investor will buy shares in a company that they believe will make them a profit. In general, a company will make a profit and distribute some or all of it to shareholders in the form of dividends. They will also keep back a portion of the profit to invest in growing the company. If the company does grow, it will grow in value and your shares will get more valuable.

Price (of a stock) is affected by supply/demand, volume, and possibly company profits

The price of a share that you see on a stock ticker is the price that people on the market have exchanged the share for recently, not the price you or I can buy a share for, although usually if people on the market are buying and selling at that price, someone will buy or sell from you at a similar sort of price.

In theory, the price will be the companies total value, if you were to own the whole thing (it's market capitalisation) divided by the total number of shares that exist in that company. The problem is that it's very difficult to work out the total value of a company. You can start by counting the different things that it owns (including things like intellectual property and the knowledge and experience of people who work there), subtract all the money it owes in loans etc., and then make an allowance for how much profit you expect the company to make in the future. The problem is that these numbers are all going to be estimates, and different peoples estimates will disagree.

Some people don't bother to estimate at all. The market makers will just follow supply and demand. They will hold a few shares in each of many companies that they are interested in. They will advertise a lower price that they are willing to buy at and a higher price that they will sell at all the time. When they hold a lot of a share, they will price it lower so that people buy it from them. When they start to run out, they will price it higher. You will never need to spend more than the market makers price to buy a share, or get less than the market makers price when you come to sell it (unless you want to buy or sell more shares than they are willing to). This is why stock price depends on supply and demand.

The other category of people who don't care about the companies they are trading are the high speed traders. They just look at information like the past price, the volume (total amount of shares being exchanged on the market) and many other statistics both from the market and elsewhere and look for patterns. You cannot compete with these people - they do things like physically locate their servers nearer to the stock exchanges buildings to get a few milliseconds time advantage over their competitors to buy shares quicker than them.

Answer 4

How I understand it is: supply/demand affect price of stock negatively/positively, respectively.

Correct.

Volume is the amount of buying/selling activity in these stocks (more volume = more fluctuation, right?).

Sort of. Higher volume means higher liquidity. That is, a stock that is traded more is easier to trade. It doesn't necessarily mean more fluctuation and in the real world, it often means that these are well-understood stocks with a high amount of analyst coverage. This tends towards these stocks not being as volatile as smaller stocks with less liquidity.

Company revenue (and profit) will help an investor predict company growth.

That is one factor in a stock price. There are certain stocks that you would buy without them making a profit because their future revenue looks potentially explosive. However, these stocks are very risky and are bubble-prone.

If you're starting out in the share market, it's generally a good idea to invest in index funds (I am not a broker, my advice should not be taken as financial advice). These funds aggregate risk by holding a lot of different companies. Also, statistics have shown that over time, buying and holding index funds long term tends to dramatically outperform other investment strategies, particularly for people with low amounts of capital.

Answer 5

Let me first give you my definitions of the words 'investor' and 'speculator'. To me, anyone looking to 'buy low, sell high' is a speculator. Only 'buy and hold' people are investors.

The news agencies love to report on changes in the price of a stock. This gives them something to talk about. So speculation is encouraged by the news media. What investors care about is dividends. In my opinion whatwhat news agencies should report on are changes to the dividend provided by a security.

I used to be a speculator, but now that I am retired I am an investor.