Stocks are an important component of retirement plans and college education savings plans. Information technology has brought the markets closer to investors. You can find detailed financial information of listed companies online, usually at no cost. Online brokers have made stock trading simple and inexpensive. However, you need to be aware of some of the market characteristics to manage your investments effectively.
Unlike U.S. Treasury bonds, stocks are not risk-free assets. Changes in a company's economic and competitive environment affect sales and profits, which determine stock price performance. Adverse economic changes could include rising unemployment, which result in lower consumer spending, and inflation, which increases operating costs. Companies that have a strong competitive position in their respective industries generate positive returns for their shareholders. Some companies pay regular cash dividends to shareholders, which is attractive for pensioners living on fixed income.
Stock markets are volatile. Price changes of several percentage points within a short period are common. Markets usually react to news events, such as corporate earnings, government economic reports and geopolitical events. Software algorithms and automated trading strategies, along with the increased participation of investors, have increased the complexity and volatility of stock markets. You can hedge against market volatility by diversifying your portfolio. Successful investors ignore short-term fluctuations because stock prices reflect the underlying fundamentals over time.
Markets offer a wide selection of stocks to suit different risk tolerances and financial objectives. Aggressive investors can buy the stocks of newly listed companies and growth companies. Although these stocks are riskier than the stocks of established companies, you could benefit from significant price appreciation. Conservative investors could buy dividend-paying stocks, which generate regular income and some potential for price appreciation. You can find stocks from major industry sectors and sub-sectors within each industry. For example, you could invest in microprocessor and software companies within the technology industry and in department stores and specialty retailers within the retail industry.
Stock markets provide liquidity because they bring together investors and businesses from all over the world. Liquidity results in narrow bid-ask spreads, which means small differences between what buyers are offering and what sellers are asking for stocks. The result is order fills at favorable prices. Information technology plays a role by increasing the speed at which the markets execute trades and disseminate information to investors and other market participants.
North American and other stock markets are interconnected and interdependent. For example, Asian and European companies list on North American exchanges, while U.S. and Canadian companies list on European and Asian exchanges. Individual and institutional investors can trade stocks using 24-hour electronic communications networks. A stock market drop in Tokyo overnight can spread to Frankfurt in the early morning hours and hit New York in time for the opening bell. Similarly, news events in Europe can ripple through global stock markets in minutes.
Regulations are necessary for fair and efficient markets. The U.S. Securities and Exchange Commission regulates the U.S. securities industry, along with the New York Stock Exchange and other markets. Securities laws ensure that investors and other market participants have access to the necessary information in a timely manner.
- stock market image by Sydney Alvares from Fotolia.com