What is investing, stocks, and trading?
Welcome to the first article in our financial “lit kit”, and congrats 🎉! You’ve officially taken your first step towards financial freedom and making money. In this article, we are going to cover the absolute basics (basically the stuff schools failed to teach you).
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Defining investing
Investing generally refers to putting money into something that you expect to make you more money over time. The actual thing you are putting money into is formerly known as an “investment” and the initial money you put in is known as “capital”. Factors like rarity and performance usually cause an investment to go up.
Example: Let’s take buying sneakers as an example. Kanye just released a limited edition drop of 500 shoes for $250. You (fortunately) are able to buy the shoes the day they release and hold onto them because you think it’s going to be more valuable in the future. Kanye then announces he’s retiring and that was his last shoe line ever. Due to the limited supply (rarity), everyone wants them and now starts offering you a $1000 for your sneakers. The sneakers are considered an investment (a great one in fact) because you bought them at a fixed price and they made you $750 if you choose to sell.
So what is a stock?
A stock (measured in shares) is a financial instrument that represents ownership in a company. Owning a share (single stock) grants you rights such as voting in the companies future and getting a proportional share of the profits. The number of shares in a company is usually fixed (finite in supply) so you generally buy them from someone who currently owns it and wants to sell.
Similar to the shoe example, if the company is doing well or people expect to in the future (speculation), they can value the stock at a higher price than what you bought it at (thus creating the profit). There’s more factors that affect a stock’s price and there’s also different types of shares (e.g. common vs preferred) but let’s keep it simple for now. If you want to dive in more, we recommend reading this article.
Example: Let’s say you bought a single share of Apple (AAPL) at $100 dollars and there are a total of 100 shares issued. You now own 1% of the shares of the company granting you that proportional power. Apple is now about to launch their new iPhone and other investors think it’s going to do extremely well. They are willing to pay a $110 per share thus driving the price up of the stock to $110 (netting you $10). The reason they are willing to pay a higher price is because they think the stock will be worth even more than $110 in the future (e.g. someone else will value it higher later on and buy it from them). Conversely, let’s say the launch fails and now people are only willing to pay $90. You’ve now lost $10 on your investment.
Investing vs trading
Investing and trading are two very similar strategies to make money. For simplicity, investing generally refers to buying something and holding it for a long period of time (we’re talking years) while trading refers to more short-lived transactions where you buy and sell more frequently (e.g. days, months, years, or even seconds).
Why do one or the other? Let’s say a stock’s price follows this pattern:
- Year 1: $5
- Year 2: $12
- Year 3: $6
- Year 4: $11
If you simply invested in a single stock at year 1 and held till year 4, you would have made $6 ($11-$5). However if you had bought the stock in year 1, sold it in year 2 and then again bought it in year 3, you would have made $12 ($12-$5 + $11 - $6) which is twice as much as if you had just invested in it and held! As appealing as that sounds, you never know when the stock is going to go up or down (timing the market) making trading *way* more risky than investing.
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