Chapter 1
Share investing online

In this chapter I explain some basic concepts and terminology associated with online share investing. I also outline why it's a good option to trade shares online, some potential pitfalls and how to avoid them. I'll start from the beginning, so if you have some knowledge and experience with shares and investing you may choose to skim quickly through this chapter.

Using the internet for share investing

Online investing is one example of how the internet has revolutionised business dealings. Now that almost all securities exchanges throughout the world are web based, the physical trading floor has been superseded. Online shopping, banking and information sourcing have skyrocketed over the past few years, while more and more investors are trading online rather than in the traditional way by calling their stockbroker.

Control

Increasingly, Australians want direct control over their shares and other financial investments. To put it bluntly, many have become disillusioned and are no longer prepared to entrust their investments to fund managers and investment advisers who charge an appreciable fee for advice that doesn't necessarily result in the promised returns. Even if a manager or adviser is able to achieve results that are better than or as good as a market index, the fees can soak up the additional benefit, with the investor no better off.

I don't mean to impugn fund managers and investment advisers, who no doubt provide a worthwhile service for many investors. I'm simply making the point that a growing number of investors want to take a more direct and informed role in their financial destiny, and the internet is the ideal vehicle for doing so.

As investors have embraced a more informed role in their financial investments, they have increasingly drawn on the web-based resources available for share investors. This trend, in turn, has been stimulated by the increasing competition among online investment service providers who are constantly looking for ways to increase their market share. They tend to use a two-pronged approach:

• reducing fees and charges
• increasing the accessibility and depth of information and services provided to subscribers and customers.

It's now possible to trade online for a cost of only 0.1% of the trade value, with a minimum charge of $10 or so. This makes online investing feasible even for small investors and provides the opportunity for worthwhile trading profits to be made with relatively small market moves.

Tip

Increasing competition and use of the internet is good news for the online investor, and you can expect continuing benefits in the future if you choose the online option.

Investing

Investing implies the following two conditions:

• You have some available cash (capital) over and above your day-to-day living expenses. Perhaps you've saved this spare cash from your income, or you may have inherited some money, received a tax refund or had a financial windfall. Or you may have derived your investing funds from an investment loan, which for the purpose of investing in shares is known as a margin loan.
• You put this cash into a financial venture with the aim of obtaining a profitable return. That's to say, you want to put the money to good use and grow your wealth, to ‘put your money to work’ as opposed to ‘allowing your money to take a holiday’.

Investment instrument

Investment instrument is a general term that applies to any asset or commodity that can be used for the purpose of investing. In this book I'll concentrate on shares, but they are just one type of investment instrument. There are many others, including bonds, managed funds, hybrids, derivatives (such as CFDs, forex, options, warrants) and fixed-interest securities such as debentures.

Tip

If you're not an experienced investor, I suggest you avoid the more sophisticated instruments and stick to plain-vanilla shares.

Capital

Capital is a business term that means wealth. It can be money that's directly available (such as cash in the bank) or the monetary value of any assets owned by a business. The only difference between cash and capital is that capital isn't necessarily in the form of directly available cash.

Tip

While a business may have a certain amount of capital (as shown in the books of account), a great deal of this may be tied up in stock or assets that don't necessarily have the same cash value if the business tries to sell them.

Stocks, shares and portfolio

One way a company (or corporation) can raise capital for start-up or growth is by ‘going public’; that is, by becoming a public company. This capital is obtained by issuing a number of shares at a certain price. The capital so obtained is known as equity capital because the capital is obtained from investors who have equity (or ownership) in the business.

Shares are units of ownership in a company, so when you invest in shares you effectively become a part-owner of the company, and this gives you the right to participate in the company's management. You have voting rights and can vote at any company meetings that are open to shareholders. Shares are also known as equities, because shareholders have an ownership position, or equity, in the company and a claim to a share of the company's assets and profits.

The total number of shares issued by a company is known as stock, but this word is also often used to describe the company itself. For example, you can own a number of different stocks (such as Telstra and ANZ Bank), and you can own a different number of shares in each. Your total holding of all shares you own is known as your portfolio.

Initial public offering (float)

When a company first offers shares that can be taken up by the general public, this is known as an initial public offering (IPO) or ‘float’. The float is usually underwritten, which means a broking firm or financial institution undertakes to purchase any shares left over if the offering is under-subscribed. Shares in an IPO can be purchased by an investor by application only using a document known as a prospectus that contains all information of relevance to potential investors.

Some floats have proved successful long-term investments (such as Commonwealth Bank and CSL), but most floats are rather risky for the simple reason that there's no track record of the business as a public company.

Tip

I suggest you avoid IPOs unless you have some very reliable information that persuades you the investment is likely to be profitable.

Securities exchange

For shares in a public company to be traded by the public at large (rather than by private treaty), they must be listed with a securities exchange; the company issuing the shares is then a ‘listed company’. Before a securities exchange can operate in Australia, it must have a licence granted to it by the Australian Securities and Investments Commission (ASIC). Most Australian companies are listed with Australian exchanges, but a few are listed with overseas exchanges because their business is more relevant to an overseas country. Some shares are listed on both Australian and overseas exchanges, and these can be traded directly by investors overseas and at times when our exchange is closed.

In order to be listed with a securities exchange, a company has to pay fees and comply with listing rules that can be quite stringent and are designed to protect investors. After listing, the company must comply with ongoing rules and may be investigated for possible breaches of rules or behaviour that appears suspect — such as a sudden change in the market price or traded volume of their shares without any obvious reason. Listing rules also stipulate that any new information of relevance to shareholders must be submitted to the exchange and be available to the public before being divulged to privileged parties or released to the press. This rule is designed to eliminate ‘insider trading’, where a select number of investors in the know can profit from information that's not available to the general public.

In Australia, the following securities exchanges operate:

• Australian Securities Exchange (ASX), which provides listing and trading in securities and derivatives including shares, futures, options and warrants. It also provides clearing and settlement of trades through the CHESS system (I'll outline CHESS shortly).
• National Stock Exchange (NSX), which specifically caters for the listing of small to medium enterprises. Not all brokers are licensed to trade on this exchange, so if you want to trade shares listed on the exchange you need to check.
• Chi-X Australia, which may potentially offer lower costs for listed securities. It is a subsidiary of Chi-X Global and is used mainly for global shares but is also often used for transactions in Australian shares.

Notes:

• In some cases, a business may choose to list its shares on several exchanges. For example, some shares listed on the New Zealand exchange are also listed on the ASX. In this case you can trade shares in a New Zealand business by placing orders with the Australian exchange.
• The ASX is by far the largest and most widely used...