Market Capitalisation is the sum value of all the shares on the market for a company. This can actually result in the ‘market cap’ being lower than the value of the company’s assets. It can also be vastly greater than the true value of the company. For example, during the dotcom boom, Yahoo had a market cap of billions of dollars, however it had no real assets or profit history.

Then we come to what is commonly called ‘speculative’ investment. This is when you invest in a company with no profit history, but you’re speculating that it will be profitable in the future. On the other hand, shares in very profitable companies with long, positive credit histories are known as ‘blue chip’ shares.

If the company you have shares in ends up making a profit, you can be eligible for what’s called a dividend. This is a return of the profit the company makes, paid to you as a shareholder.

There are a couple of ways in which you can trade shares, either through a stockbroker, or trade them yourself using an online share trading portal. The value (or price) of your shares is determined by what the rest of the market thinks they are worth. If the market thinks they’re worth 10% more than the price you bought them for, and you sell at that price, you’ll make a 10% profit. If the share price falls or devalues by 10% and you sell, you’ll incur a 10% loss on your investment.

Many people buy shares and then sit on them or hold for a long time – three, five, ten years or more. This principle reflects a common-held belief that the value of shares is most likely to rise over the long term, although it may go up and down in the short term. When we refer to ‘volatility’, we refer to this short term movement.

People tend to trade in a volatile market just so that they are doing something. This often means people sell shares when the price is dropping, because they feel the price is going to keep falling and they want to minimise their losses. On the other hand, this means they’re often also buying shares when the price is high, in the belief that the price will keep rising. Buying high and selling low is exactly the opposite of what people need to do to make a profit on the share market. But it’s human nature’s way of dealing with the stress of trading.

So how do you make money trading regularly, while avoiding these sometimes terrible mistakes on the market? What many people don’t know is that you can make money in a falling market. That’s because there are other instruments apart from shares that you can buy and sell on the stock market. The most common of these are Exchange Traded Options (usually just known as options) and Contracts for Difference (CFDs).

To create these shares, companies make them available by ‘floating’ on the stock market through an Initial Public Offering (IPO). Companies do this when they want to expand, and need cash to do so. The company is valued by a professional valuer and then broken up into a pre-determined number of pieces – or shares.

Once the shares have been sold, they can be traded an unlimited number of times on the stock exchange. Exchanges – like the Australian ASX – exist because the people who bought the stock initially don’t want to keep it forever. Ultimately they’ll want to sell their shares, to make a profit if the price goes up, avoid further losses if the price falls, or to convert their shares to cash. So after the initial IPO, the company doesn’t make any more money from the buying and selling of its shares. All that profit (or loss) goes to investors.

So, we know the value of shares goes up and down, we see it on the news every day. But who, or what, determines the value of your shares?

The people, companies and stock exchanges that participate in the buying and selling of shares, are known collectively as ‘the market’. It’s the market that determines the value of your shares. So how does it do this?

The truth is that the value of your share is determined by perception – what the market thinks the company you hold stock in is worth. This psychology can be influenced by all kinds of things – product announcements, mergers and acquisitions, executive team changes, etc. So the share price simply reflects what people who want to buy a share in the company are prepared to pay, and the price those who are selling shares in the company are willing to sell for.

** Part 2 of this article will cover how shares are traded and how people approach investing.

++++++++++++++++++

Daniel Kertcher has taught more than 100,000  people how to trade the stock market since he established his company, Platinum Pursuits, in 2001. He holds DFP and PS146 qualifications as well as ASX qualifications in options. He has authored two books on stock market trading, as well as the world’s only options trading board game, Call Up Put Down.