The stock market's steady gains lately have a lot of readers who are new to investing wondering how to get started. Maggie in Florida wants to know how to go about buying a few shares. And Rob is wondering: Just who decides how much you pay for stock when you buy it?
Do I have to use a broker to start investing in the stock market? I'm an average person interested in buying some stock to have just another means of income for retirement. I don't have a vast amount of money to invest. I'm just beginning.
-- Maggie, Jacksonville, Fla.
There’s no rule that says you have to use a broker — just the way you’re free to buy or sell a house without listing it with an agent. But much like any market, the price you get — as a buyer or seller — is usually better if you’re looking at the same prices that every other buyer and seller is looking at.
You also have the benefit of seeing the minute-by-minute prices that other buyers and sellers are paying. The two primary American stock markets — the New York Stock Exchange and the NASDAQ — are basically gigantic auctions with millions of buyers and sellers trading billions of shares a day. So you’ll probably get a better price there than you will on Craigslist or eBay.
Some companies will sell you their stock directly and let you reinvest the dividends in new shares or buy more with cash. You’ll save on the broker’s commission, but you’ll have to deal with one company at a time. And redeeming shares (selling them back to the company) usually involves more paperwork than placing a trade with a broker.
To get started with a broker, you’ll have to open an account with a brokerage firm, which means signing an agreement with detailed terms governing how your transactions will be handled, among other things. Read this agreement carefully, line by line. If there’s something you don’t understand, call up and ask. Don’t sign until you understand why every clause is there. You’ll learn a lot about investing by understanding the agreement; some terms are written for your benefit, some are written to benefit the broker.
When it comes time to actually place the trade, however, you don’t necessarily have to deal with a human being. Many discount brokerages will let you trade online by yourself, where your orders are routed along with those placed by human brokers.
As a beginner, you’ll want to start slowly. Stocks don’t guarantee an income for retirement — in fact, they are a fairly risky way to get started. So you may want to start with a mutual fund or a stock index fund (which tracks the overall performance of an index like the S&P 500.)
You can always ask the broker for ideas about which stocks to buy, but remember that the broker makes money whether the stock goes up or down. Many of the so-called “experts” who recommend stocks on TV or in the newspaper may already own the stock they're so enthusiastic about; if they can convince more people to buy that stock, it could help the price go up — and help themsleves make money. The hardest part about any kind of financial advice is knowing whether the advice is being given for the benefit of the advisor or the client.
If you decide to pick your own stocks or mutual funds, research every one thoroughly – just as you would if you were buying a car or a flat screen TV. Advice from your sister-in-law is fine. But understand what you’re buying and why you’re buying it. And start thinking about when you’re going to sell as soon as you buy.
Is Oneshare.com a legitimate business for me to purchase stocks from?
-- V. M., Bloomington, Minn.
We haven’t dealt with the company, but have no reason to doubt they deliver what they say they will. But it’s an expensive way to buy stock.
We recently went to their site and priced a share of General Electric, which closed at about $38 a share on Friday, Jan. 12 . If you bought a share from Oneshare.com, you’d pay $38 for the stock, plus a transfer fee of $39. Then add $10 shipping and handling -- for $87.
If you bought the stock through a discount broker, you’d probably pay a commission of, say, $20 a trade. (Same for 1 share or 100, so if you bought a typical 100-share lot, the cost would be 20 cents to trade a single share.) Cost per share: $38.20.
On the other hand, Oneshare.com is selling the idea of stock certificates as a wall decoration, suitable for framing. But you can just as easily do this through a broker: just set up an account, buy the stock and then ask to have them send you a physical certificate. You’ll need to pay a transfer fee (one brokerage we called charges $15) and pay shipping (say, $5 via US Mail.) That brings you to $38 + $.20 (commission) + $15 (transfer fee) + $5 (postage) = $58.20.
How does a stock broker like Charles Schwab or ScottTrade continuously change price for stocks so it changes with supply and demand? Is there an algorithm? Are stock prices set by an objective machine or a subjective human? Is the price constantly set by the company behind the stock?
-- Rob M. (Address withheld)
The prices you see scrolling by on the bottom of the screen on CNBC are records of actual trades between a willing buyer and a willing seller. Each trade is recorded, beamed electronically to millions brokerage houses, Web sites and other sources of stock quotes, and becomes a benchmark – the “market price” - for the next trade. In the end, it’s just one big auction. Kind of like eBay, but a lot faster.
It all starts when Bill Buyer in Boise and Sadie Seller in Savannah call up their broker (or go online) and place a trade. Bill says: “I want to buy 100 shares of Global Nanotech.” At roughly the same time, Sadie places an order to sell 100 of her shares.
Most orders (buy and sell) are placed “at the market” – which means “I want to buy or sell now, just get me the best price you can.” All these orders are routed through a series of brokers, dealers, and computers and, in the case of the New York Stock Exchange, end up at a physical trading post, where thousands of other orders are flooding in at the same time. As they come in, these buy and sell orders are matched up, by computers and/or human beings, based on the price of the last trade recorded for that stock (the “market price.”)
An order to buy 1,000 shares may end up being filled with 10 orders to sell 100 each; if the market is moving quickly, the sellers of those 100-share lots may not get exactly the same price. The matching process involves a running list (an “order book”) of buy and sells requests which are paired off as prices match up and the trade is “cleared.”
Things get a little more complicated if you want to add conditions to your trade — like demanding a specific price. Some buyers and sellers will use what’s called a ‘limit order’ — “I won’t sell unless I get $50 a share” – in which case the trade can’t go through unless a buyer is found who is willing to pay that price. Sellers can also place what’s called a “stop loss” order — “If the stock falls below $50 a share, sell it.”
If the price a buyer is willing to pay (the “bid” price) is higher than the price a seller is willing to offer (the “ask” price), there’s a “spread.” In our case, Bill is willing to pay $52 and Sadie is asking for $50. When that happens, the dealer or market maker matching the trades sometimes pockets the difference. If the spread goes the other way — Sadie wants $52 for her shares and Bill is only willing to pay $50 — in theory the trade won’t go through. On the New York Stock Exchange, the people matching trades (called specialists) are supposed to dip into their own pocket, if necessary, to match trades and keep the market moving.
If Sadie wants $52 and she's the only seller, however, and Bill has placed a market order, then $52 becomes the market price and that’s what Bill pays. And if there are a lot more buyers than sellers at that moment, that higher price — the new “market price” — may bring more sellers into the market, providing plenty of orders on both sides at that price, where it will settle for awhile. But if there are more still buyers than sellers at $52, the price will likely go to $55. At some point, the price reaches a point where the number of buyers and sellers are roughly in balance. (The same scenario works on the way down with more sellers than buyers.)
But if trading gets too lopsided — everyone wants to sell and no one wants to buy — the exchange may stop trading for what’s called an “order imbalance,” which is usually caused by a piece of very good or bad news about the stock — or even a rumor being passed around by traders. After everyone’s had a chance to digest the news, trading starts up again at a different price and (usually) things go smoothly again.
Once a trade is made, it’s then recorded and the price is sent around the world as the next “stock quote” (and the number of shares added to the “volume” number for that stock.) Bill and Sadie get confirmation notices showing the price they got for their trade (minus the broker’s commission.) Electronic bits are then moved from Sadie’s brokerage account to Bill’s. (Physical stock certificates – or other pieces of paper representing financial securities — rarely change hands these days.)
The result is a steady stream of millions of shares traded that reflect the price buyers and sellers are getting for their shares. Unless you’re a day trader, the mechanics of each trade — and the small, minute-to-minute price moves that result — don’t much matter. But no one person or group sets the price. We all do.