Stock Market Education

One common way to classify stocks is to make an assessment as to whether they are “cyclical” or “defensive”.

These two terms represent, as you can probably guess, two types of industry or stock that are at stark odds with the other.

Let’s take a deeper look at what these terms mean, and how they interplay with the stock market.

The terms cyclical and defensive are used to show how closely correlated a company’s share price, or a sector’s performance, is to fluctuations in the economy.

Cyclical stocks are those whose fortunes are tied to the strength of the economy. They perform well when the economy is strong, and will decline when the economy is performing badly.

In other words, cyclical stocks perform according to the big picture, where as defensive stocks generally perform solely on their own merits.

In general, defensive stocks tend to offer more steady products and services. Business doesn’t necessarily boom when the economy is strong, but also doesn’t suffer too badly when the economy is struggling.

Defensive stocks are non-cyclical because they experience solid profits regardless of the motions of the broader economy.

Defensive stocks, as we noted above, are not considered to be tied to the market. However, their fortunes are still party tied to how the broader economy is going.

Defensive stocks are seen as safer, and should perform better in a bear market. Even if they don’t manage to go up during a bear market, they shouldn’t fall by as much as cyclical stocks in bad times.

Because defensive stocks and cyclical stocks are polar opposites, when cyclical stocks are doing poorly, defensive stocks tend to do well.

An example of defensive stocks to choose in a bear market would include those that are in the healthcare industry, namely CSL Limited which is a biopharmaceutical company.

Additionally, other sectors that are generally considered most defensive in a bear market are officially known as the consumer staples and the utilities.

Generally, some experts believe defensive sectors include industries such as drugs, healthcare, information technology and food on a wider spectrum.

Defensive stocks are defensive in nature because the demand for them tends to be strong no matter how the general economy is performing. This is because defensive stocks produce items considered necessities, and product demand should continue regardless of the big picture.

For instance, people will always need electricity in their homes, so utilities companies tend to perform steadily over time; it’s not like you will buy twice as much electricity when times are good!

There are two ways to make money out of shares. The most obvious is when you sell a stock for more than you buy it for. That’s called capital gains, and that garners most people’s attention. This usually occurs when the Australian stock market is in a bull market.

The other way of making money is less glamorous, but just as important. When you own shares in a company, you literally own a small slice of the company. Typically, when a company makes a profit, it distributes the money to its owners. You, as a shareholder, are one of the owners (admittedly usually a small one) and this money is called a ‘dividend’. This is an important point to consider when buying shares.

Now almost all of you will know what a dividend is, but not everyone knows about the dividend yield. The dividend yield is simply the total dividends for the year expressed as a percentage of the share price.

Dividend yield = annual dividends (in cents) / share price (in cents)

For example if you put $1000 into the bank, and you receive $60 in interest for the year, then the return or ‘yield’ is 6% ($60/$1000). The same goes for dividends. If you invest $10,000 in a share, and you receive $300 of dividends, that’s equal to a yield of 3%.

One of the high dividend stock picks were Macquarie Infrastructure (MIG) and Tabcorp (TAH) with a dividend yield of 16.81% and 9.23% respectively. Usually, Blue Chip Stocks provide a fairly high dividend yield.

A company can pay virtually whatever dividend it wants, from nothing up to a maximum of around 10%. Most companies pay between 2% and 5% and the average across the entire market is currently around 3.7%.

For example in the Australian Stock Market, Amcor (AMC) is a fairly high yield stock which had a dividend yield of 5.8%. It went ex-dividend on 2 March 2010 which does not entitle a new investor to the dividend declared if they purchased the share on the ex-dividend date.

Broadly, companies fall into two categories – growth and income. Growth stocks are companies that are expanding and don’t pay out much of their profits in dividends, because they need the money to grow. Mining stocks often pay out little in dividends.

Income stocks are more stable companies that pay out regular and predictable dividends. Banking stocks and property trusts generally pay a high dividend yield of around 5% or higher.

On Saturday February 27, a powerful earthquake struck Chile, causing a significant loss of life and damage to the country’s infrastructure.

The earthquake also had the effect of disrupting commodity markets, in particular the market for copper.  This is an important concept when doing stock market research.

Commodity prices are sensitive to a number of different factors.  Demand for commodities is one factor that can drive up commodity prices.

Another factor is a disruption, or threat of disruption, to the supply of commodities.  In economics, a shortage of supply leads to higher prices for a good.

Commodity markets work in a similar fashion, as a shortage in the supply of a resource tends to bring up its price. This highlights the importance of economic fundamentals in any stock market research.

Chile accounts for 30% of the world’s copper reserves, and its share of global production is 35%.  This makes Chile an important player in the market for copper.

When the earthquake struck there were reports that the country had suspended some copper production.  However, most copper mining was done in areas outside of the quake zone, so production was not materially affected.

This didn’t stop copper prices from soaring after initial reports of the earthquake, as the mere threat of a copper shortage was enough to drive up its price.

So when conducting stock market research, remember that there doesn’t need to be an actual disruption in commodity supply for prices to rise, just the threat of disruption is enough.

Investing in commodities first requires that you take an opinion on a commodity. For example, you might like the look of a “safe” commodity – one that does well when the market is floundering – and choose gold. Silver is also a safer commodities bet, and a good hedge against inflation and other major world events.

If you believe the economy is strengthening, you might choose copper, which is considered a proxy for the strength and direction of the overall market. Or you might decide to invest in oil if you’ve noticed it going upwards, or agricultural commodities such as coffee, cocoa, and cattle.

These days when people ask themselves how to trade or buy commodities, CFDs looks like a good option for Aussie traders. Rather than buying, trading or investing in the commodity itself, you’re making a bet on the movement of the commodity – whether it will rise or fall. In this case, you’ll use a CFD provider (such as CommSec) to place an order on the commodity, putting in your entry orders, your stop orders, and your take profit orders.

However you may decide that investing in commodities directly is a more lucrative option, and trade global futures from Australia with a non-CFD broker.  That is, you need to find an Australian futures broker who can trade on US (and other) futures markets for your commodity of choice.

The ASX trades futures over grain, electricity and wool, as well as options over grain futures. Futures are traded on DTP, the Derivatives Trading Platform (aka CLICK).

Contract for Difference (CFDs) are becoming an increasingly common investment strategy for those wanting to make money from the Australian Stock Exchange. For people who are new to the market, however, they can be difficult to grasp at first glance.

Firstly, let’s get one thing straight in this lesson on CFD education: CFDS aren’t shares. In fact, CFDs have all the benefits of trading shares, without you actually having to physically buy, own or sell the shares.

CFDs are almost like a board game version of trading real shares in the market. They mirror the performance of a share, or an index. With CFDs, you make an agreement with a provider (like IG Markets or like CommSec) about the opening and closing price of a share or index you’re looking at. You are making a deal with the CFD provider to exchange the difference between the opening and closing prices of the share or index.

Say you see a company you think is going to crash. You can contact your CFD provider to specify the price of the company’s shares (the beginning of the contract) and what level you think the shares will fall to (the close of the contract). If and when you hit your target, the CFD provider will pay out cash on the difference between the starting share price, and when the contract is closed.

It doesn’t take a lot of CFD training in order to get your head around the CFD concept. You can advance your CFD knowledge by checking out the CFD Report at the Australian Stock Report (www.australianstockreport.com.au).

When asking yourself the question, “What shares should I buy now?” it’s important to do some research on companies that have caught your eye.

When you’re looking at what shares to buy, you’re examining the company, its sector and its place in the overall market, if you’re doing your job correctly.

A major part of fundamental analysis is researching a company you want to buy shares in. As the name suggests, this form of analysis is the way to get to the “fundamental” heart of a company and analyse its worth. If you’re looking at what shares to buy, what better way to go about it than to analyse your preferred companies? This is what fundamental analysis really is – analysing the financial data that is “fundamental” to a company – its earnings, its profits, its dividends.

Fundamental analysis can help you identify some bargain stocks out there that have been caught up in the market maelstrom – and sold off well past their value simply because of the negative market sentiment. Of course, when you’re researching what shares to buy, technical analysis is equally important – looking over the company’s chart, and identifying trends.

The best way to “suss out” what shares to buy is to combine fundamental and technical analysis to give yourself some perspective on a company. This is also the best way to build an individual strategy to trading and investing, using whatever approach is personally suitable.

Also remember when you’re asking yourself what shares to buy now, look at the company’s role in its industry and the greater perspective. You might want to buy shares in a company that looks strong with a good balance sheet and decent fundamentals – but the industry may be facing toughness, and this could weigh on the company.

Learning about the stock market isn’t difficult, with the mechanisms not being as complex as you might think.

A stock market is a public market for the trading of company stocks and derivatives at an agreed price. These are reflected as securities listed on a stock exchange as well as those only traded privately. Stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organisation, whose job it is to bring together the buyers and sellers.

Major countries have their own stock exchanges, and ours is the Australian Stock Exchange (ASX). The Aussie sharemarket doesn’t have a physical trading location, such as a trading floor. You instead buy and sell shares using a computerised trading system which links stockbroking firms
around the country.

Learning about and understanding the stock market can be an important tool for you to make money, as history suggests that Aussie shares have performed other types of investment over the long-term.  There are over 1500 companies on the ASX, covering most sectors of the economy, including financial services, industrials and healthcare.

If you decide to invest in the stock market, you can decide how much money you invest, into which companies and which sector, thus controlling your future. As you learn more about the stock market and understand how it works, you’ll be able to decide what shares you want to buy, and what shares you’ll want to sell or hold. When you buy or sell shares, your orders are entered into the computerised system at your stockbroking firm. The system finds a seller in the market that is willing to trade shares for the price you want to buy them. Your order is then placed in the order it is received, and voila! – you’ve made a footstep into the stock market.

Learning about and understanding the stock market is easy. For more information, you can visit our website, check out the education centre at the ASX website (www.asx.com.au) or speak to your broker if you open an account.

Buying and selling shares in the stock market isn’t the same thing as buying or selling at a physical market, say like a food shop or market stall.

The Aussie sharemarket doesn’t have a physical trading location, such as a trading floor, like you see in films about Wall Street. You instead buy and sell shares using a computerised trading system which links stockbroking firms around the country.

Of course, before we start to invest, we need to know how to buy shares.

First, you need a stockbroker to do so for you, and there are more than 90 stockbroking firms across Australia – some offer financial advice, and are called full service brokers. To set up an account with a broker, you’ll need a minimum amount of money to put into your account, pay a brokerage fee, be over 18 years of age and of course fill out all the paperwork. When you buy or sell shares, your orders are entered into the computerised system at your stockbroking firm. The system finds a seller in the market that is willing to trade shares for the price you want to buy them. This is how we buy and sell shares – by finding other buyers and sellers waiting to ‘match’ your order.

Now that you know how to buy and sell shares, you then need to know how to pay for them! Payment is made within three days of the broker executing your order, and if you have sold shares you need to provide access to the shares so they can be given to the new owner. The money will come out of an account with your broker or through a linked bank account.

When you buy shares in a company, you are both financially and personally invested in that company for as long as you stay in the trade.

After you sell your shares, you’ll still be affected by your former stake – by being either poorer or (ideally) richer.