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Investing in Stocks with Basic Knowledge of Economics

1 of 11 in Series: The Essentials of Investing in Stocks and Bonds

Stocks represent ownership in companies, and stock markets are the places where stocks are bought and sold. Those places may be made of bricks and mortar, like the New York Stock Exchange, or they may be computer networks, like the Nasdaq.

In years past, when someone bought stock in a company, he would receive a physical certificate that proved how many shares he owned. These days, if you buy stock in a company, you don’t get a pretty piece of paper to prove it; you generally get electronic confirmation of the trade.

Having a working knowledge of basic economics is crucial to your success as a stock investor. The stock market and the economy are joined at the hip. The good or bad things that happen to one have a direct effect on the other.

Understanding basic economics can help you filter financial news to separate relevant information from the irrelevant in order to make better investment decisions. Here are a few important economic concepts to be aware of:

  • Supply and demand: Supply and demand can be simply stated as the relationship between what’s available (the supply) and what people want and are willing to pay for (the demand). This equation is the main engine of economic activity and is extremely important for your stock investing analysis and decision-making process.

  • Cause and effect: Considering cause and effect is an exercise in logical thinking. If you were to pick up a prominent news report and read, “Companies in the table industry are expecting plummeting sales,” would you rush out and invest in companies that sell chairs or manufacture tablecloths? When you read business news, play it out in your mind. What good (or bad) can logically be expected given a certain event or situation?

  • Economic effects from government actions: Nothing has a greater effect — good or bad — on investing and economics than government, which controls the money supply, credit, and all public securities markets. Government actions usually manifest themselves as taxes, laws, or regulations. They also can take on a more ominous appearance, such as war or the threat of war. A single government action can have a far-reaching effect that can have a direct or indirect economic impact on your stock investments.

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