Riding The Bull -- As Americans Pour Money Into Wall Street, Here's An Inside Look At How The Markets Work
Seattle Times Business Columnist: Times News Services
NEW YORK - At the opening of trading on a recent day in the stock market, shares in Physio-Control were lower. Not much, but enough to attract a little attention.
One of the people attracted to Physio stock that day was Landon Ray, 30, a new breed of day trader operating in a counterculture trading room a few doors away from the imposing old-money facade of the New York Stock Exchange (NYSE). Ray doesn't know Physio is based in Redmond, Wash. He doesn't know it makes a life-saving medical device for heart-attack victims. He doesn't know it is a company providing more than 850 people their livelihoods.
And he doesn't care. "The stock's moving," he says. That's enough for him. He buys shares of Physio and sells them again in less than 90 seconds. He has guessed right and pockets $250 on the trade.
Watching Ray trade makes the stock market seem like one huge incomprehensible gamble. But it is into this mysterious world that more and more ordinary people are venturing, with fewer and fewer knowing exactly what it is all about.
But learning what it is all about is key.
The stock market has become a major source of wealth for many of us. Where we once invested in staid and government-protected bank certificates of deposit, we now have much of our sense of financial well-being tied up in a riskier investment that can go up - or down - freely.
Recently, it has gone up; it's a bull market. In the first part of this year alone, the market as measured by the Dow Jones industrial average has set a half-dozen records and has closed above 9,000 for the first time in its history. Many investors talk blithely of Dow 10,000. The widely quoted Dow average is based on a composite of the prices of stock in 30 big-ticket companies.
Just last week, the market put on another spurt, gaining almost 200 points Thursday and Friday to close at 9,147.07, less than 40 points shy of its closing record of 9,184.94, set April 21.
The size of the market has also increased dramatically. The value of all stocks in 1980 was $1.44 trillion. At the end of last year, that had grown to about $13 trillion. A stack of $1 bills representing $1.44 trillion would extend about 93,000 miles into space, more than a third of the way to the moon. A stack representing $13 trillion would extend 851,894 miles, or about two complete round trips to the moon.
As recently as 1980, the average volume of shares traded on the NYSE was 45 million a day. On the Nasdaq (stands for National Association of Securities Dealers Automated Quotation) market, it was 26 million shares. Today, the two exchanges trade a combined average of more than 1 billion shares a day. The NYSE is upgrading its computers to the point where it will be able to handle 6 billion shares a day.
How important has the market become? A recent study based on data from the Federal Reserve Board showed that we Americans have a larger share of our money invested in the stock market than at any time in the past 50 years.
The study showed that stock investments made up 28 percent of household wealth - a measure that includes houses, cars and other tangible assets as well as financial assets. And stocks accounted for 43 percent of financial assets, which also include bank accounts, bonds and mutual funds. Those numbers have more than doubled since 1990.
VOICES OF CAUTION
But there are voices that caution against regarding the stock market as a magic arcade that creates and dispenses wealth.
"Remember you don't get rich investing," says Ernie Ankrim, a portfolio adviser for the Frank Russell Co., a pension-fund consulting and money management firm in Tacoma. "You only increase your wealth from the dollars you made elsewhere."
What does that mean? After three years of rapidly rising stock prices and a great first quarter of this year, many of us are feeling richer as the value of our stock holdings rises. In fact, aside from our paychecks, stocks are the likely source of much of our feeling of financial security.
That has been translated into the economy, which is now nearing its eighth year of growth, the second-longest period of sustained economic progress since the end of World War II.
But there is another side to the market, one that has not been seen for quite a while: Stocks can go down quite suddenly and dramatically.
With so much invested in stocks, a sharp market decline could seriously change our sense of financial well-being. And the economy's.
As recently as the early 1970s, the market went down - and stayed down. Both 1973 and 1974 were years of decline for the Dow Jones industrial average - the Dow lost almost half its value, dropping 44 percent, during those two years. If that were to happen today, the market would be at about 4,000 in May 2000.
In 1970, the Dow ended the year at 838.92. In 1979 it was at 838.74.
Few expect it to stay so flat today, given the amount of money entering the market and the computer-programmed "circuit breakers" in place to hold sell-offs in check, at least temporarily. Besides, investors have been taught by recent events that almost every downward slide in the market is a buying opportunity.
In years past, the biggest asset for many of us was the home, making the real-estate market far more important than the stock market in personal finance. In the late 1980s as today, skyrocketing home prices in the Seattle area helped people here feel much better off. And when interest rates declined, home refinancings and home-equity accounts skyrocketed, putting some of that new-found wealth in our pockets.
The recent strength in the real-estate market here probably means homes are still the largest store of potential wealth in the Puget Sound area. It's hard to compete with a housing market where the average price is $246,000. But the stock market is a close second and gaining. For some, such as Microsoft workers who are sitting on a pile of unexercised options totaling more than $20 billion, the market is the major store of wealth.
Boeing, Starbucks, Seafirst and a number of other companies here are increasingly using options for employee compensation. Options, the right to buy stock at a set price at some time in the future, have increased dramatically in recent years, pushing more and more people into the often arcane, confusing and downright scary world of stocks.
To help understand the stock market, let's go back to what Landon Ray is doing in New York.
The New York Stock Exchange is situated in a classic building at Wall and Broad streets in the financial district of lower Manhattan. Any time you've seen a news photograph or a film clip about the stock market, that's the NYSE.
Landon Ray is what's called a day trader - some in the establishment refer to him as a "bandit" - someone in and out of the market very quickly. He operates out of a trading room at 50 Broad St., a few doors down the street from the NYSE and light years away in tradition, importance and dress code. Take the elevator to the second floor and walk through a sparsely furnished office. A gray metal folding chair for visitors sits next to a receptionist.
Ray sits in a drab, darkened room, trading stocks, eyes glued to the computer screen before him. About 50 others - almost all male - are in the same room. Ray is trading - for himself alone - on the difference in price between dealers who want to sell stocks and dealers who want to buy stocks. Ray can actually make money doing this.
Why is he trading Physio's shares? "It was on the list of the top 10 down stocks today. The stock is moving."
Does he know what Physio does? "No, don't care, the stock is moving."
Ray is perhaps the direct opposite of people like you and me investing in the market these days. For most of us, investing in stocks is a way to ensure our retirement, pay for college education or increase our wealth so we can enjoy the good life.
We buy and hold. We turn to mutual funds to help us spread our risk. We invest in Starbucks or Nordstrom because we know them and know they are good companies.
Do you understand that Ray is trading "inside the spread" of stocks listed on the Nasdaq exchange? Should you care? Do you know what happens when you check the box for aggressive growth on the mutual fund in your company 401(k) form? Should you care? Are you different from Ray?
The questions about the stock market are as varied as the 8,000 to 10,000 companies listed on the various exchanges. Trying to find the answers to those questions can be frustrating because many of the experts in the market assume you know what is going on.
That is not really the case.
"Most people want to buy a car, put it in drive and aim it," says Richard Syron, president of the American Stock Exchange. "They don't care about the transmission and how it works. We're the transmission."
The questions are simple, but they are basic to what happens in the market.
Who handles all those trades? Who accounts for a share of stock that you sell on the NYSE or the Amex or the Nasdaq, also known as the over-the-counter market? Who gets my money when I buy stock? Who sends me proof that I own shares when I buy?
Why does the stock market go up or down, anyway? Will I look stupid if I don't get in the market now? How can I tell when it is time to get out of the market?
Many questions. Here are some answers.
THE TRADING FLOOR
The floor of the New York Stock Exchange looks like some sort of financial ant farm. Everyone is scurrying about doing things, but exactly what is hard to fathom.
For all that chaos, some important things are happening, most of them having to do with your sense of wealth. Here is where stocks are traded, where buyers and sellers come together to determine the price at which the stocks change hands.
Stocks seem mysterious. But they're not.
When you own a share of stock, you own a piece of the expected profits of the company. You also own a piece of the potential losses of the company. Both are important to keep in mind.
Companies go to the stock market for several reasons, but the chief one is to raise money. Cavanaugh Hospitality is a Spokane-based hotel company that converted an office building in downtown Seattle to one of their hotels a few years ago. Cavanaugh recently "went public," listing its shares on the New York Stock Exchange.
It was an exciting day for them, listing on the day the market first crossed the 9,000 mark. Company officials got to ring the bell at the opening of trading. A huge cream-colored flag with the company name hung outside the exchange all day.
But the real impact of listing is that the company received $72,191,250 from investors who bought its shares. It will use the money to pay down debt, allowing it to expand into other markets, and for other corporate needs. And its stock will start trading on the exchange with investors trying to decide whether to buy the stock or sell it.
The market itself is no different from one of those used-car swap meets. You have an '89 Nissan Sentra to sell, and someone wants to buy a good used car at a good price. You bargain and agree on a price, with perhaps the help of an auctioneer who knows the going price for a clean '89 Sentra.
On the floor of the NYSE, broker Brian Toolan is Boeing's "used-car" auctioneer. He is the specialist who helps keep order in the market for stock of the Puget Sound area's largest employer.
"There was a good report out on Boeing this morning," Toolan says. "So it is trading up. It's come off its bottom around $50."
Translation: An analyst who follows Boeing has put out a research report. The analyst believes the company's production problems are near to being resolved and has urged that stockbrokers recommend Boeing to their customers. The result is that more people want to buy Boeing stock this morning than sell it. Boeing's price rises.
Not everyone wants to buy. A floor broker comes to Toolan and wants to sell 200,000 shares for a client. (Brokers know each other and know who they work for. However, they request that specific trades remain confidential.)
Toolan explains what is happening to the broker who wants to sell Boeing stock. Toolan can match 50,000 shares right now at the current price - he has that many orders to buy. The seller agrees and writes the order on a ticket that is handed to a clerk. Trade done.
Seconds later, another broker is at Toolan's trading post.
"What's the market?" he asks.
"Up a teenie," says Toolan, who like most stock-market specialists seems to have the ability to carry on several conversations at once. A "teenie" is a sixteenth of a dollar in the trading of the stock.
The Boeing seller, now with 150,000 shares to unload, bargains briefly with the new buyer - maybe for 10 seconds - and 50,000 more shares change hands, up another teenie.
Meanwhile, more orders are coming into Toolan's trading post electronically from brokers around the country. Toolan matches the buy orders and sell orders to keep the market moving and the price current. After an hour of trading, Boeing is up almost 50 cents a share, because there were more buyers than sellers. Volume has been strong, more than 500,000 shares. It's a good day.
NASDAQ'S MARKET MAKERS
On the other side of town, in a high-rise building with a view of the Hudson River, another part of the market unfolds. In the giant trading room of Salomon Smith Barney, brokers are buying and selling stock, trying to buy as stocks are headed up and sell as they're going down.
This is where many of the orders processed by Toolan and his counterparts come from. These brokers are working for clients - individual investors, pension funds, large family trusts, mutual funds with money from 401(k) plans - hundreds of different sources for orders for stock.
In a tiered part toward one end of Smith Barney's large trading room, brokers are buying and selling stocks on the Nasdaq market. One dealer handles nothing but Microsoft, the largest company on the Nasdaq and one that trades millions of shares a day.
Nasdaq is the new kid on the block. The over-the-counter market existed for many years with a cumbersome paper system. In the early 1980s, it was automated and became a computer-based trading system. It has grown rapidly since then to become the second-largest stock market.
To understand the market, it's essential to note the critical difference between the auction-style trading system used at the New York Stock Exchange (and the much smaller American Stock Exchange) and the computer-driven, dealer-style Nasdaq system.
One writer described auction markets as a swap meet, where car buyers and sellers deal with one another, vs. Nasdaq's used-car lot where buyers and sellers trade with dealers.
Under the auction system, investors send orders through their brokers to the floor of an exchange. Brokers representing buyers and sellers gather at a specific location for each stock and negotiate prices. If a block of shares is offered for sale or purchase and no broker steps forward to make a deal, an exchange specialist can buy or sell from his company's own account. The haggling is supposed to yield prices that efficiently reflect the forces of supply and demand.
In a dealer system, buyers and sellers also send orders through their brokers, but there is no exchange floor for haggling. Instead, the brokers trade with dealers called market makers, who use computers to post prices at which they are willing to buy and sell specific stocks. (The main computer that lists the stocks and executes orders is located in Trumbull, Conn., with a backup operations center in Rockville, Md.)
Your broker may deal with only certain market makers even though others trade the same stocks. Critics say this system results in a lack of competition and that sweetheart deals between brokers and market makers put some individual investors at a disadvantage.
The difference between the market maker's "buy" price and the somewhat higher "sell" price is called "the spread" and represents the market maker's profit. Several years ago, Nasdaq was embroiled in controversy when regulators found that market makers were colluding to keep the spreads unnaturally wide. That meant buyers paid more than they would have in an honest market, while sellers received less.
In 1996, Nasdaq settled its price-fixing dispute with the Securities and Exchange Commission by agreeing to spend $100 million to improve its market oversight. Arthur Levitt, chairman of the Securities and Exchange Commission, pushed for changes that resulted in smaller spreads and ensured that pros don't get better prices than small investors.
THE FLOOR BROKER
There is a faded blue line that runs around the floor of the New York Stock Exchange. It separates the floor brokers' work space from the formal auction part of the market. Amid the ant-farm chaos of the exchange floor, Joseph Cangemi studies an order to sell $50 million in stock. He's a floor broker with Francis P. Maglio & Co., and plays a part in the 600 million shares or $26 billion traded in a typical day.
"He's wrong to sell, but let's do it," Cangemi says of his client, and sets off across the blue line to the specialists in the stock. The trade is done quickly, but Cangemi is still able to help his client a bit by spreading the order out among several buyers. The specialist in the stock helps out by picking up 5,000 shares from the electronic orders that have come to his position.
Floor brokers, who buy or sell stock by negotiating prices with other brokers, are outspoken - to say the least - and capable of calling out a multimillion-dollar sale with a few words or market shorthand.
Cangemi, 36, came to Wall Street as an intern while still in high school in Queens, N.Y. A customer on his newspaper route had suggested he might like the Street and hired him for the summer. After studying finance in college, Cangemi returned to the firm and eventually left to help start Maglio.
He is pushing for more technology on the floor, especially a hand-held computerized tool that would help him trade stocks more efficiently. While 90 percent of trades on the floor are processed electronically already, there is more to be done, he says.
Cangemi's job is to look out for the firm's customers and make the best trade that he can on the stock in question.
He doesn't always agree with the decision to buy or sell, but he'll execute the trade as well as he can.
Dressed in a gray suit and Rockport walkers, Cangemi hustles about the floor gripping pads of pink and white paper used to jot down offers and trades.
Approaching the specialist for a tobacco company, he asks about the latest action on the stock. Numbers flash buy on what is called the ticker, an electronic display board that records each trade on the floor. Minutes later the deal is done.
Will technology replace him? No, says Cangemi, because it is only by visual, person-to-person contact that investors can get the best price on a trade.
And after all, that's why the markets are there in the first place.
Stephen H. Dunphy's phone message number is 206-464-2365. His e-mail address is: email@example.com ------------------------------- Stock talk Some terms to know
American Stock Exchange - Called the Amex, more than 700 small to medium-size companies list here, with a heavy weighting to oil and oil-service companies.
Annual report - Corporate document issued each year to detail to investors and others a company's financial performance and outlook.
Bear - One who believes the outlook for a market or stock is down.
Bid and ask prices - Used mostly in the computer-based Nasdaq market, the bid is the selling price; the ask, the buying price. The difference is the spread.
Big Board - Nickname for the New York Stock Exchange.
Blue chip - The stocks of large, historically solid companies. Boeing and Weyerhaeuser would be considered Blue Chip.
Bull - One who believes a market or stock is headed higher.
Capital - Money invested to start or expand a company.
Closing price - The price paid at a stock's final trade of the day.
Common stock/preferred stock - The two types of stock an investor can buy. Most is common stock and may or may not pay a dividend. Preferred stock usually does have a dividend, and usually it does not change as the price of the stock goes up and down. It is called preferred because if the company should liquidate or fail, preferred stockholders are paid first.
Dividend - A payment of cash or additional stock to stockholders, as approved by the board of directors.
Dow Jones industrial average - A composite index of stock prices representing 30 of the nation's biggest companies.
Equities/shares/issues/stocks/securities - All terms for what you buy when you buy a percentage of the future profits or losses of a business.
Float - That part of a company's stock held by the investing public, as opposed to company insiders.
Institution - A large organization, such as a pension or mutual fund. Institutions account for more than half of all trading volume.
Initial public offering (IPO) - the first offering of a company's stock to the public.
Market maker - A firm that buys and sells stock for its own account, hoping to profit through quick turnarounds. Specialists on exchanges and Nasdaq dealers are market makers.
Market value or market capitalization - Total value of a company, determined by number of shares of stock outstanding multiplied by the stock price.
Nasdaq National Market System - National Association of Securities Dealers Automated Quotations, a computerized national trading system for more than 4,000 public companies. Microsoft, Paccar, Starbucks and other new or high-tech companies tend to be listed there.
Nasdaq Composite Index: The index tracks the Nasdaq market. Because there are many high-tech companies on Nasdaq, it has become a measure of the high-tech industry.
New York Stock Exchange - Founded in 1792, NYSE now lists more than 3,000. businesses. A company must meet stringent requirements for size and profitability in order to be listed, and that limits entry to the world's most prestigious stock exchange.
Point - Used to track a stock. "Up a point," means up $1 a share.
Portfolio - All the various stocks or bonds held by one investor or institution.
Securities and Exchange Commission - Federal regulator of securities.
Standard & Poor's 500-stock index: Used by professionals because it includes a much broader range of public companies than the Dow Jones industrial average. The list contains the 500 largest publicly held companies.
Stock symbol - Letters by which companies are recognized for stock-trading. NYSE symbols normally are one, two or three letters; Amex symbols are usually three; and Nasdaq symbols are usually four.
Sources: Seattle Times staff; "Wall Street Words," by David Scott; Barron's "Dictionary of Finance and Investment Terms;" and "The Nasdaq Handbook," produced by the National Association of Securities Dealers. ------------------------------- How to know how market is faring
Here is a quick guide to various measures of the stock market.
Dow Jones industrial average: This is the most widely used measure of the market, covering 30 large U.S. companies. It is hardly industrial anymore, with companies such as Disney listed, though it is still thought to be a representative mix of big companies. The Dow's main strength is its longevity; it has been used to measure the market for a century. Its weakness is that it is a relatively small slice of the stock market.
Standard & Poor 500 stock index: This is an index used by the professionals because it is a fairly wide look at stocks. It is the 500 top companies by market capitalization. Its strength is its breadth: It is a proxy for how the entire market is doing.
Nasdaq composite: It is the best measure of the over-the-counter market, or Nasdaq. It has become a way of looking at the technology because so many high-tech companies are listed on Nasdaq and are among its top stocks. Microsoft, Intel, Compaq, Dell and others are listed here.
Russell Indexes: Another index with a wide following among professionals. The beauty of the Russell indexes - there is a Russell 1000, Russell 2000 and Russell 3000 - is the ability to slice and dice the indexes many different ways. With 3,000 stocks in the largest grouping, it is also an even better proxy for the market than the S&P 500. The indexes are compiled in the Northwest by the Tacoma-based Frank Russell Co.
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