The Beginner’s Guide to the Stock Market

What is a Stock Market?

Think of a fish market full of vendors selling different types of fish. When you walk in, you have all different types of fish available to you in a centralized place. If you’re looking for halibut, you don’t have to walk down 3 blocks to your local fish store to buy it.

The stock market works the same way. The stock market exists for issuing, buying, and selling stocks that trade on a stock exchange.

The stock market serves 2 important purposes:

  1. Provide capital to companies that they can use to expand their businesses. If a company issues 1 million shares of stock that initially sell for $10 a share, then that provides the company with $10 million of capital that it can use to grow its business
  2. Give investors the opportunity to share in the profits of the companies. Investors can profit regular dividends (a given amount of money per share of stock someone owns). The other way investors can profit from buying stocks is by selling their stock for a profit if the stock price increases from their purchase price

Here’s a beginner’s guide to stock and bonds if you want to learn more.

What is a Stock Exchange?

The stock market is a general term which is related to a place where stocks are traded. A stock exchange is more specific to the place where the trading is executed, such as BSE, NSE, NYSE, NASDAQ.

Similar to the fish market example. Think of a stock market as the generic term for a fish market. The stock exchange is like a specific fish market such as the Tsukiji fish market in Japan or the Pike Place Fish Market in Seattle.

There are many large stock exchanges around the world, but the 2 largest ones in the United States are the New York Stock Exchange (NYSE) or NASDAQ.

New York Stock Exchange (NYSE): Founded in 1792, it has a market capitalization of $22.9 trillion and about 2,400 listed companies. The NYSE alone accounts for roughly 40% of the world’s stock market capitalization.

NASDAQ: Founded in 1971, NASDAQ is considered the Mecca of technology companies because many of the world’s largest technology companies such as Apple, Microsoft, Facebook, Amazon, Alphabet, Tesla, Cisco, and others are listed here. As of November 2018, NASDAQ had a market capitalization of $10.8 trillion with an average monthly trading volume of $1.26 trillion.

Primary vs. Secondary Markets

The simplest way to put it is that when a company first enters into the stock market and issues stocks, these stocks are sold in the primary market. When these stocks are released to other investors, they are sold in the secondary market. Shares issued in the primary market are issued by the company, whereas shares sold in the secondary market are shares that were previously held by another investor.

Primary Market:

When a company publicly sells new stocks and bonds for the first time, it does so in the primary capital market. This market is also called the new issues market. In many cases, the new issue takes the form of an initial public offering (IPO).

Companies may hire investment bankers to obtain commitments from large institutional investors since the company only has a short period of time to meet the required volume they need to sell. The shares on the primary market are often sold at a discount due to the urgency to sell and can be very volatile since it’s very difficult to predict the demand for the stock in the secondary market.

For most of us, you don’t have to worry about the primary market unless you have millions available to invest in these companies.

Secondary Market:

The secondary market is where securities are traded after the company has sold its offering on the primary market. It is also referred to as the stock market.

A broker typically purchases the securities on behalf of an investor in the secondary market. Unlike the primary market, where prices are set before an IPO takes place, prices on the secondary market fluctuate with demand. Investors will also have to pay a commission to the broker for carrying out the trade.

There are many brokers to choose from. Most banks have a brokerage, but they charge around $6.95 CAD per trade. CIBC Investor Edge for example charges a flat fee of only $6.95 per online equity trade, with no minimums.

There are also discount brokerages such as WealthSimple Trade that offers no commissions on trades. The discount does come with some limitations. You might not be able to find the complete list of stocks to purchase, limitations on type of order such as the lack of ability to short stocks, and timing issues where your buy orders are not executed right away. But for most beginners, WealthSimple Trade has all the functionalities you need.

Getting Listed on the Stock Exchange

To have your company listed on one of the major stock exchanges, there’s a lot of work and requirements to meet. For example, the NASDAQ has the following four sets of requirements before your company will even be considered.

Requirement 1: Earnings

The company must have aggregate pre-tax earnings in the prior three years of at least $11 million, in the previous two years at least $2.2 million, and no single year in the prior three years can have a net loss.

Requirement 2: Capitalization with Cash Flow

The company must have a minimum aggregate cash flow of at least $27.5 million for the past three fiscal years, with no negative cash flow in any of those three years. Also, its average market capitalization over the prior 12 months must be at least $550 million, and revenues in the previous fiscal year must be $110 million, minimum.

Requirement 3: Capitalization with Revenue

Companies can be removed from the cash flow requirement of the second standard if its average market capitalization over the past 12 months is at least $850 million and revenues over the prior fiscal year are at least $90 million.

Requirement 4: Asset with Equity

Companies can eliminate the cash flow and revenue requirements, and decrease its marketing capitalization requirements to $160 million if their total assets total at least $80 million and their stockholders’ equity is at least $55 million.