How to Start Investing In the Stock Market

Here are some of the most important and widely used stock market terms, Learn what they all mean, because you'll come across them frequently.

Stock Market Term 10 -
Sell short - Selling short (also called "shorting" a stock) isn't a term that applies only to investors under 5' tall. Selling short refers to a strategy where the investor bets that a stock is going to fall, and if it does they'll realize a profit. Basically to sell a stock short an investor will borrow from their brokerage house in order to purchase a specific number of shares of a specific stock. They never actually own the shares, they're on loan to the investor.

At some point in the future, they have to repay those shares to the brokerage house. If they were correct, the shares will cost them less than they paid. For example, if they short 100 shares of XYZ corp at $10.00 a share, it costs them $1,000, except that they don't actually have to pay the $1,000 yet. They are obligated to repay the 100 shares of XYZ at some point in the the future, however. In this example if XYZ corp's stock drops to $7.00 a share, the investor can repay the brokerage house the 100 shares and realize a $3.00 per share profit.

One could have made tremendous profits shorting mortgage company, financial, and banking stocks in the past couple of years, but the shorting strategy does have a downside. One downside of short selling is that the upside is limited to an amount per share that's equal to the share price. Obviously there isn't any more money in there. So, in this example, you could earn a maximum of $10 per share on XYZ. On the other hand in a traditional purchase your upside profit potential is pretty much unlimited. If XYZ went to $100 at some point in the future, you'd have made $90 a share.

Stock Market Term 9 -
Equity - An equity is analogous to a stock. It's an ownership stake in a company. When an investor purchases a share of stock they're purchasing a portion of ownership in the company. This is also called taking an equity position in the company. It's one of the two main ways a company raises money. Selling ownership in the company is called equity financing. The other way is selling bonds or notes, which are financial instruments that a company promises to repay with interest. Selling company bonds or notes is called debt financing.

Stock Market Term 8 -
Margin - Buying stocks on margin is borrowing money from your broker to buy shares of stock. This is strictly regulated by the Federal Reserve. It is a way an investor can use leverage to grow their investment, because they're using borrowed funds. This is just like when you purchase your house with 10% down, you're leveraging the 10% down payment to control a much larger asset. When the house appreciates you get the benefit of the entire appreciation, although you only paid 10%. As you can imagine, an investor can lose big time if the stock goes down, because you are leveraging both gains and losses.

The Fed requires investors to have a 50% equity in their accounts when buying on margin. So if you want to buy 100 shares the ubiquitous XYZ corp's stock at $10 per share you have to have at least $500 in your account to do so. In reality, because of Federal Reserve regulations, you can't get a margin loan from broker unless you have a minimum of $2,000 in your account.

Stock Market Term 7 -
Call Option - A call option is a contract that two investors enter into where one sells the other the right to purchase a certain security at a certain time for a certain price. The buyer is not obligated (hence the term "option") to make the purchase, but the seller is obligated to make the sale for the agreed upon price, should the seller so choose. The buyer realizes their profit because they are buying an option to purchase a stock they are hoping they can sell on the open market for more than they paid. It's similar to (but not the same as) employee inventive stock options.

Say XYZ corp is trading at $10 a share and the buyer purchases options to XYZ for $12 a share. The seller locks in a $2.00 share profit because of the $2.00 premium. The buyer pays the $2.00 per share premium as a nonrefundable deposit. Should the stock rise above the $12.00 share price, the option buyer can then buy the stock for the $12.00 agreed upon price, and sell them for whatever the market value is on the day they sell them. The difference between the option price and the sales price is the investor's profit.

Stock Market Term 6
Put Option - A put option is basically the flip side of a call option. It gives an investor the option to sell a specific stock or commodity at an agreed upon price (known as the the "strike price") at some point in the future. When an investor purchases a put option they are hoping the asset is going to lose value before they exercise the option.

For example, if they buy a put option for, you guessed it, XYZ corp, at $20 a share and XYZ drops to $15 a snare, they'll realize a $5 per share profit, minus the amount they paid for the option. If they paid $2 per share for the option their net profit would be $3 per share. It works like this:

The owner of the put contract buys XYZ at the market price of $15 a share then sells it as per the terms of the put option for $20 per share. They earn $5 per share, but had to pay $2 per share for the option, so they net $3 per share.

Stock Market Term 5 -
Market Order - A market order is an order to buy or sell a stock that will be executed on a stock exchange. When you place an order with your broker that includes no other conditions, that's an example of a market order. You agree to buy or sell a stock at what ever the market price is when the trade is executed. Due to the time difference between when the trade is requested and when it's executed, there can be substantial difference in the price you buy or sell a stock at compared to where you wanted to buy or sell at.

For example, if you're looking at a stock on your computer screen and it's sitting at $20.00 a share, it may have moved to $21.75 from the time you place the order to the time a trader actually buys the stock for you on the exchange. Remember that stock exchanges are just markets filled with buyers and sellers. The price offered and the price that sellers are willing to sell for changes constantly as the trading day progresses.

Stock Market Term 4 -
Limit Order - As the name suggests a limit order is an order to buy or sell some stock that's limited by price. There are buy limit orders and sell limit orders. When you place a limit order, the transaction can only occur when the stock's price reaches, but doesn't exceed a certain price. This can occur either on the high or low side.

For example, you want to buy some shares of XYZ Corp. (You just love that company) and it's currently trading at $10.00 per share. You can place a limit order that will not be executed if the stock is trading at greater than $12.00 at the time the order is executed. That prevents you from paying more than you wanted to for the stock, which can easily occur with a fast moving stock due to the lag between the time your order is placed and when the trade is actually executed on the stock exchange.

You can also use a limit order when selling. Say you're holding XYZ Corp at $10.00 per share. You can place a limit order to sell your shares but set a limit at some amount, say $8.50, below which you don't want the trade to be executed. If XYZ falls below $8.50 before the trade can be executed, the transaction won't be made.

Stock Market Term 3 -
Stop Order - The stop order is basically the flip side of the limit order. With a stop order, you set what's called a "stop price". When the stock reaches your selected stop price the trade will be turned into a market order, not before. As with the limit order, there are sell stop orders and buy stop orders. These are great for locking in profits or limiting losses.

For example if an investor is holding XYZ at $10.00 per share, they can set a sell stop order at $9.00/share. That way if the stock drops to $9.00 it will trigger a market order to sell. If the investor (you?) bought the stock at $7.00 they are locking in the $2.00 per share appreciation as profit. Keep in mind that they may not receive the entire $2.00 due to the time difference between when the market order is placed and when the trade is executed.

Stock Market Term 2 -
Stop-Limit Order - If you really aren't comfortable with the market fluctuations that can cause your trade to be executed at a price above or below your stop or limit order, you need to use what's called, appropriately enough, a "stop-limit order". The stop-limit order is a marriage of both types of orders. As with the stop order you set a stop price. The difference is that the when the stop price is reached the order converts to a limit order, rather than a standard market order.

Why wouldn't you always use a stop-limit order? Well sometimes you can't, because your broker prohibits it with certain classes of stocks, such as over the counter bulletin board (OTC-BB) stocks. When they allow you to place these orders should be clearly spelled out in their service terms. The other reason you may not want to use a stop-limit order is that, as with a standard stop order, if the price of the stock never reaches the limit, your trade will not be executed.

Stock Market Term 1a -
Ask - You'll see the term "ask" on your computer screen when looking at different stocks and their activity. The Ask amount is what the seller of the stock is willing to sell it for.

Stock Market Term 1b -
Bid - Bid is the flip side of Ask. It's what the buyer is offering to pay for a specific stock.

Stock Picks Rule 1
Pick the stock of a company that just became, or is about to become an industry standard. One of these that's received some press recently is Dolby Labs. I've been familiar with this company for many years because I owned a business in the audio / video industry and have been involved in it for decades. Not only has Dolby been the standard in cassette tape noise reduction since the dawn of time, they weren't content to develop technology for a format with a limited lifespan.

Dolby labs has also been one of the three main companies producing surround sound formats for theatrical movie releases, and Dolby Digital has been the standard in home surround since the days when it's predecessor, Dolby Pro-Logic, ruled the roost. Now Dolby has gone and gotten their Dolby Digital + and Dolby Digital True HD appointed the official audio formats of the both next generation video disc standards (too bad the industry couldn't agree on just a single next-generation video disc format, but that's a story for another day), HD-DVD and Blu Ray Disc. They are also in car audio, cell phones, and personal media devices.

Like Microsoft(MSFT) in the early years, they are debt free and have substantial cash reserves in the bank. Dolby has fantastic consumer brand recognition, thanks to years of putting their logo in front of people in theaters, on cassette tapes and on consumer and professional audio equipment. They have only been public Since early 2005, have an operating margin of almost 40% and their year of year quarterly revenue growth is over 25%. Even better, unless they get complacent, they should continue this for years, because they are in a growing market and they have only 1 direct competitor in the consumer space. That is DTS Inc., a good company, but they are 1/3 the size, only 20% of the revenue, and without Dolby's portfolio of technologies, patents, and licensing deals.

Stock Picks Rule 2
Look for stocks of companies that are well positioned in small markets that are about to become very large markets. They can be production, development, or supply companies. One example here would be the bio fuels industry. In addition to the cachet such investment possess because they are perceived to be green and environ-friendly, it is a market positioned for dramatic growth in the not to distant future. Currently there are many small companies competing for dominance in the space. As the price of petro-products continues to increase, it makes the development of bio fuels economically attractive. A company or two will emerge to dominate the industry and form the backbone of a new fuel economy.

As an indicator of the growth potential in this market, the USDA reports that 75 million gallons of biodiesel were used in 2005 for transportation. This is but a drop in the bucket compared to the 38 billion gallons of diesel fuels used for transportation. The growth here will be tremendous. In 2006 the city of Cincinnati alone used 1.8 million gallons of biodiesel to power city vehicles. In August of 2007, Louis Dreyfus Corp. of France opened the world's largest (for a brief period) biodiesel plant in Claypool Indiana. Using Soybeans, this plant produces 88 million gallons of biodiesel every year. That is 15% more than the entire United States used of the fuel only 2 years previously.

There were 165 commercial biodiesel plants operating in the U.S. by August of 2007. The 4 other largest biodiesel plants were owned by -
- Delta Biofuels - Mississippi - 80 million gal - opened May 2007

- Archer Daniels Midland Corp. (ADM) - North Dakota - 85 million gal - opened August 2007

- Green Earth Fuels of Houston LLC - Texas - 86 million gal - opened July 2007

- Imperial Grey's Harbor - Washington State - 100 million gal - opened in August 2007

Numerous others produce between 20 and 50 million gallons of the stuff annually. The demand for this fuel should only grow, especially as some of the problems with ethanol fuels, such as the 20% gas mileage penalty and the hydroscopic nature that makes it difficult to transport by pipeline (requires truck transport, which is much more expensive than pipelines), receive more publicity. Weather the huge use of soybeans for biodiesel substantially drives up the price of soybeans remains to be seen; any commodities investors out there?

Stock Picks Rule 3
Choose the stock of a company that is legislated into prominence. Anytime legislation is passed requiring, or restricting the use of a company's products or services, there are investment opportunities created. In the case of the requirement of product or service, demand will increase. In the case of restriction or outright bans, demand for alternative products and services will grow.

An example is when states require their residents to be insured. That creates a larger market for insurance companies allows greater profits. When the U.S. and foreign governments legislated certain safety features in automobiles, such as airbags, there was obviously greater demand for all components of them.

That is one reason astute investors watch the legislative process like hawks scanning a field for mice. There are investment opportunities created in the halls of government every day. Watching for them can show you when you can profit from an opportunity, or when it is time to cut and run.

Use these 3 rules to help pick stocks that will grow your portfolio in this new year (and beyond).

We'd all like to hit the investing equivalent of that massive, 585 footer into San Francisco Bay. The truth is that, although investors occasionally strike it big with one well placed trade, you've got far weaker odds of hitting the investing equivalent of a home run as you do striking out repeatedly. Hey, it's just like in the majors. Those that live by the long ball often die by it as well.

Most investors know better than to count on hitting a home run every time they pick a new stock. More often investors try to mitigate the risks of seeking the long ball by filling most of their portfolio with less risky investments. If they've done their homework, and the market cooperates, they'll make out pretty well. The question is why look for the home run stock at all? The chances of picking one of those meteoric companies that can single-handedly fund your retirement is exceedingly slim. By the way has anyone ever noticed that meteors tend to go down? I don't know where the term "meteoric rise" came from, but most likely it was from someone standing on their head.

What are your chances of landing that big, home run investment, so you can retire at 32 and drive your new GT2 merrily off into the sunset? Well, there are almost 4,000 different stocks listed on the OTCBB. Some are great companies to be sure, and are using the capital they raise from issuing shares traded there to fund their growth in the hopes that one day they'll move to one of the larger exchanges. The problem is that there are so many risks inherent in trading such issues that most investors, even very aggressive ones, are better off leaving these alone. Your chances of finding the next Google, Microsoft or Intel among the OTC-BB or pink sheet companies is exceedingly unlikely.

In most cases companies with that much on the ball and that much investor support will simply IPO on one of the larger exchanges. None of the aforementioned companies were ever penny stocks, despite Internet rumors to the contrary. Google IPO'd at almost $100 per share and Microsoft, who raised an amazingly small $58.7 million from their $21/ share IPO in 1986, never came close to penny stock status. By the way, IPO underwriter Goldman Sachs collected a $541,000 fee from MSFT for their services. By the way, Microsoft never needed the IPO as financing. In 1986, they had cash reserves of approximately $38 million, but they'd given so many incentive stock options, they felt they'd soon have to register under SEC rules. Never liking to lose control of time or place, Bill decided to get a jump on the whole thing.

Lets take a look one small step up the stock hierarchy, micro cap stocks. Do you have a good chance of making hay there? The typical definition of a micro cap stock is one with a market cap of smaller than $250 million. I went a bit smaller, to companies with market caps with under $100 million on any of the three major exchanges. Surely the risk to investors there is less than on the OTC-BB or pink sheets, right? If nothing else they are subject to more oversight, and should (in theory) be less likely to experience major moves in stock price precipitated by surreptitious actions of either company insiders or Internet price manipulation schemes. There are about 565 stocks meeting the under $100 million figure. Of these, an astonishing 478 are trading at 10% or more below their 52 week high. That is about 85%. Now this may not be too surprising, given that the market has dropped precipitously over the previous 6 months.

Taking a look at larger, more established firms, we find that there are 236 companies with a market cap between $10 billion and $25 billion, and that 192 of them meet the criteria of trading at 10% or more below their 52 week high. That is about 81%.

I found 217 companies with market caps of greater than $25 billion, but below $200 billion. How many of these companies are trading at greater than 10% below their 52 week high? About 165 of them, or 76%.

When looking at the really big players in the corporate world, those with market caps exceeding $200 billion. There are 12, a fairly small sample. 10 of them are trading at greater than 10% below their 52 week high and half are 15% below it.

What does it all mean? It looks like there is an positive correlation between a company's market cap and their recent stock performance, until the very largest companies are reached, at which time the relationship goes bad. In different market and economic conditions this may not hold true of course.