Understanding how the stock market works

Oran A. Hall, Gleaner Writer

QUESTION: I am keen to learn about the Jamaica Stock Exchange (JSE) and how to go about trading in the securities listed on it.

- Hamilton

PFA: The stock exchange is a centralised marketplace for buying and selling stocks and other listed securities such as bonds and preference shares. It also provides a mechanism for companies to raise capital for expansion purposes by selling and issuing securities such as stocks and bonds.

Common or ordinary stocks represent ownership in a company and give the shareholder certain rights: the right to dividends, if declared by the board; the right to information about the company in which the investment is made; the right to maintain the proportionate share of ownership in the company; the right to vote in matters such as electing the board of directors; and the right to share in the assets in the event of dissolution.

Preference stockholders are entitled to certain rights and privileges not enjoyed by ordinary shareholders.

The main right is the entitlement to dividends at a pre-determined rate, usually expressed as a percentage, which must be paid out of earnings before any dividends are paid to ordinary shareholders.

Preference shareholders, in the event of the liquidation of a company, are usually entitled to a stipulated portion of the assets of a company in preference to common shareholders.

Bonds are certificates issued by a government or company which represent evidence that a fixed sum of money was borrowed on which the borrower promises to pay the lender a specified amount of interest for a specified period and to repay the loan at maturity. Only bonds issued by corporations are listed on the JSE.

Unlike ordinary shareholders, bondholders are not part-owners of the company and do not have any say in the management of the company once they receive the interest due to them.

The stock exchange itself does not own, buy, or sell any of the securities that are bought or sold. Securities are owned by the shareholders who may be individuals, companies, pension funds, or stockbrokers.

To buy or sell stock on the stock exchange, you should go to any of the stockbroker firms authorised to trade on the exchange. Stockbrokers are able to advise you to help you make suitable decisions, but you must open an account before you can transact business with them.

Transactions are done on a cash basis, that is, you are required to pay in cash or by cheque for the stock purchased. You must have clear ownership of any stock you are selling.

The Jamaica Stock Exchange has had an electronic trading platform since January 2000, so brokers do not physically have to go to the floor of the stock exchange to trade for their clients, themselves, or their companies.

Once you have chosen the stock you want to purchase, you will indicate how many units you want, and the price you are willing to pay. You may place a market order which specifies the number of shares you want to buy or sell at the best available price.

You may, however, place a limit order whereby you specify the maximum price you are prepared to pay, or the minimum price you are prepared to sell at.

You may choose to place a day order, which is valid only for the day on which the order is placed. Once the order has been executed, your broker will issue a contract giving details, including commission and other charges, of the transaction.

The establishment of the Jamaica Central Securities Depository in June 1998 has made it unnecessary for owners of stock to hold physical stock certificates. Brokers register the stockholdings of their clients in accounts held at the JCSD. The computerised book-entry system aids the change of ownership of securities electronically between buyers and sellers without the need for the exchange of physical certificates.

The Jamaica Stock Exchange operates on a T+3 settlement cycle meaning that buyers have three business days after the transaction date to pay for the stock, and sellers have three days to deliver the stock, now easily facilitated by the JCSD.

Protection for investors

Like other stock exchanges, the Jamaica Stock Exchange offers protection to investors. It has a compensation fund to indemnify the losses of clients of broker-members in certain situations. It can also intervene and run and/or wind up the affairs of a broker-member where the interests of its clients are at risk.

You may have noticed recently that the JSE opened a junior market for small and medium-size companies thereby giving the investing public an opportunity to participate in the growth of such companies.

You are responsible ultimately for how you fare on the stock market. Do not rely entirely on the advice of your stockbroker. Do your own research and make sure that the decisions you make are consistent with your goals. Investing is a long-term business, so you need to be patient.

Visit the website of the JSE - www.jamstockex.com - for information on the stock market.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Financial Planning', offers free counsel and advice on personal financial planning.Email: finviser.jm@gmail.com