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Home > Asset Management Checklists > Trading in Equities on Stock Exchanges

Asset Management Checklists

Trading in Equities on Stock Exchanges


Checklist Description

This checklist outlines equity trading on stock exchanges.

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Definition

Equity trading is the buying and selling of company stocks and shares. Stocks and shares in publicly traded companies are bought and sold through one of the major stock exchanges, which serve as managed auctions for stock. A stock exchange, share market, or bourse is a company, corporation, or mutual organization that provides facilities for stockbrokers and traders to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities, trading in other financial instruments, and the payment of income and dividends. To be traded on a stock exchange, a company has to be listed on it. Some international companies are listed on more than one exchange.

A share is one of a finite number of equal portions in the capital of a company, and a person owning shares is called a shareholder. Shares entitle the owner to a proportion of distributed, non-reinvested profits known as dividends, and to a proportion of the value of the company in the event of liquidation. Shares are classed as voting (Class A), with the right to vote on the board of directors, or non-voting (Class B). This right can often affect the value of the share.

The value of a publicly traded company is called its market capitalization. This is calculated as the number of shares outstanding (as opposed to those authorized but not necessarily issued) times the price per share. A company’s market capitalization should not be confused with the fair market value of the company, as the price per share can be influenced by factors such as the volume of shares traded.

A stockbroker is a qualified and regulated professional who buys and sells shares and other securities on his or her own behalf or on behalf of investors. Equity trading can be performed by the owner of the shares or by a stockbroker authorized to buy and sell on behalf of the owner (in return for a commission). Most trading is carried out on electronic networks, which offer the advantages of up-to-the-second prices and information on the number of shares bought or sold, together with speed and a low transaction cost. The initial public offering (IPO) of stocks and shares to investors is done on the primary market and any subsequent trading is done in the secondary market.

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Advantages

  • Holding shares allows an investor to spread investment risk and participate in some of the world’s premier companies.

  • As a general rule, shares as an investment vehicle have, over the long run, outperformed all other types of investment.

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Disadvantages

  • Share prices can be very volatile, and the value of shares depends on a number of external factors over which the investor has no control.

  • Different shares can have different levels of liquidity, i.e. demand from buyers and sellers. Normally, blue-chip stocks have greater depth and liquidity. The lower the market capitalization, the lower the liquidity, which may affect the ease with which the shares can be sold. Liquidity also affects share prices because, if the shares have low liquidity, it is sometimes more difficult to convert them into cash.

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Action Checklist

  • To trade shares, you must have an account with a stockbroker or a licensed intermediary (financial planner, accountant, etc.). This is to ensure that the trading environment is secure. Many new investors start using stockbrokers but others prefer to do their own research and use online brokers.

  • Most brokers require you to have an account to ensure that you have the funds to cover orders. Some online brokers require you to have an account with an associated financial institution before you can begin trading.

  • When placing a buy or sell order, there are two ways you can trade. Shares can be traded at market order, which means buying at the prevailing market price. The alternative is the limit order, where you set the minimum or maximum price.

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Dos and Don’ts

Do

  • Research the company, and take into account any risks you feel might arise. If in doubt, use a stop loss to help protect your investment.

Don’t

  • Don’t invest on the basis of tips unless you are extremely confident of the source. More often than not, tipped shares—like tipped horses—will end up as “also-rans.”

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Further reading

Books:

  • Maginn, John L., Donald L. Tuttle, Jerald E. Pinto, and Dennis W. McLeavey. Managing Investment Portfolios: A Dynamic Process. 3rd ed. CFA Institute Investment Series. Hoboken, NJ: Wiley, 2007.
  • Mobius, Mark. Equities: An Introduction to the Core Concepts. Singapore: Wiley, 2006.
  • Morris, Virginia B., and Kenneth M. Morris. Standard & Poor’s Guide to Money and Investing. New York: Lightbulb Press, 2005.

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