Companies have two choices when they want to raise money to grow their business: to borrow from a bank or issue stocks.

A share represents a proprietary interest that a person holds in a company and shareholders fully participate in the dividends, capital and surplus upon the winding-up of the company The key advantage in issuing shares (or equity) is that the company does not need to pay back the capital amount or make interest payments. Instead, shareholders – the people who buy those shares – can hope to receive dividends and see a capital gain on their investment.

Share trading involve risk. Traders accept these risks every day as they risk a portion of their capital in the hope of receiving a return on their investment. You win some and you lose some. However, the better you understand the risks that affect you as a trader the better you can protect yourself from those risks.

Traders have to confront many forms of risk as they evaluate and manage their trades. For instance a trader who owns stocks in Wal-Mart (WMT:xnys) has to be concerned not only with how well Wal-Mart as a company is performing but also with the general condition of economies around the world. They also have to be concerned with how well the U.S. stock market is performing and whether or not the value of the U.S. dollar is strong or weak, rising or falling.

As you , you will have to understand all manner of risks if you are to counteract the forces that are going to push your share prices higher and lower. Once you understand the risks facing your trades it is possible to minimize the affect they can have on your profitability.

The New York Stock Exchange (NYSE), the London Stock Exchange (LSE), Tokyo Stock Exchange and the JSE Limited (JSE) are all, simply, markets for stocks.

Stock exchanges have two purposes. Firstly, they are places where traders can buy or sell stocks and, secondly, companies can use them to raise cash to expand their business by selling new stocks to investors.

Stock exchanges provide investors with two advantages:

• They reduce the risk of investing by providing a transparent pricing mechanism for trades.
• They police listed companies. Stock exchanges operate in a strict regulatory environment and companies have to comply with stringent listing requirements.

Investors use share indices to track the performance of the underlying stocks and sectors. When we refer to "the market", we're actually referring to an index that is a proxy for all the stocks listed on that exchange.

An index is defined as "a statistical measure of the changes in a portfolio of stocks representing a portion of the overall market". That means that when an index is up, most share prices have increased and vice versa.

In a nutshell, the forces of supply and demand are the key determinants of changes in share prices. In the simplest terms, the share price will go up if more people want to own a share than are prepared to sell it. Over time, a share price will track the underlying trend in the company's earnings: if earnings (and dividends) grow consistently, the share price should follow.

But there are other aspects that affect investor appetite for stocks including the performance of international markets, general economic growth, sector or company-specific news, share buybacks and futures trading.

Overall, share prices tend to go up when the economic news is good as this means companies should see their earnings increase. In addition, good news from a certain sector or company can drive share prices up as investors expect good future earnings.

There are other buyers of stocks apart from investors, including companies (through share buybacks) and futures traders. They also affect the demand/supply equation.

We've all heard that there's no such thing as a free lunch – and this is as true of investing as anything else. Over time, stocks have outperformed other asset classes – like government bonds, property and bank deposits – but this comes at a cost. That cost is that investing in stocks is riskier than other asset classes. The old adage "high risk, high return" means that an investor who takes on the higher risk of investing in stocks expects a higher return for doing so.

These are some of the risks of investing in stocks:

• Share prices can – and do – go down as well as up. Investors can reduce their risk by doing their homework and always knowing exactly what they're investing in. That includes evaluating "tips from friends".
• Some stocks can be illiquid. This means that they can be difficult to trade, often because there is a controlling shareholder who owns a large percentage of the company and is not selling those stocks on the market. This means that a share can be difficult to sell. To avoid this, invest in more liquid stocks.
• Companies do not have to pay dividends. This is not necessarily a bad sign if the company is keeping that money to invest in its future growth, but is a risk for shareholders who bought that share for the dividend income.
• If a company goes bankrupt, shareholders may lose the entire value of their investment. Ordinary shareholders only receive what's left over once creditors and preference shareholders have been paid their due.
• Companies can disappoint the market by reporting lower-than expected earnings. This can mean the share price either falls or lags behind the growth of its peers.
• Share prices factor in the market's view of management's competence and integrity. Scandals, such as the revelation of fraud or poor corporate governance, can hurt the share price.

But you shouldn't be frightened of investing in stocks. Most listed companies are well-run businesses and their share prices should increase over time.

Ultimately the value of your investments would be determined not only by the return those stocks generate in future, but also by how little it cost you to invest in the first place.

As the graph on the next page shows, you would be better off investing directly in stocks rather than letting someone else manage your money. In this example you can clearly see how much of the value of your long-term investment you "donate" to third parties through upfront and annual fees over 20 years (Investment A vs Investment B). If you believe that you don't have the skills to manage your own portfolio of individual stocks, consider buying an Exchange Traded Fund (ETF). These let you buy a basket of shares at relatively low cost.

Different investment scenarios: direct investing vs third-party managed funds

Investors buy stocks for capital growth, income, or both. Shares usually generate income through the payment of dividends. Simply, dividends are the distribution of a portion of a company's earnings to its shareholders.

However, the size of this dividend is not known to investors as it depends on company profits and is at the discretion of the company's directors. This is unlike a money market deposit, where investors know what they will earn upfront.

Dividends are decided upon and declared by the company's board either annually or half-yearly. But directors can choose to use cash that could be paid out to shareholders for other purposes, including reinvesting it in the company's operations, buying back stocks or paying off debt.

Investors who require income from their share investments should choose stocks with a high dividend yield – the dividend payment as a percentage of the company's share price. Like an interest rate, the dividend yield tells you the income return you will receive from that investment.

For investors, the key advantage of receiving dividend income is that it is tax-free in the hands of the recipient.

Tax implications

a) Tax on dividends received

Although South African residents are liable for dividend withholding tax (DWT) at a rate of 15%in respect of South African companies listed on the JSE Limited, the tax rate in other jurisdictions will vary. For example if you earn dividends on any stocks held in the USA, 30% will generally be withheld from that income. South Africa has double taxation agreements in place with certain countries which could reduce the amount of withholding taxes payable. In certain circumstances you are however able to reclaim some taxes that you paid on these dividends. Note that Standard Bank currently does not offer this type of tax reclaim service in-house but we can refer you to an internationally recognized tax reclaim service that can assist you. Contact us for further details in this regard or sign up for the tax reclaim service by selecting the relevant button within the trading platform.

b.) Tax on profit made during trading

Profits on investments will be taxed – and investors need to be aware of the different ways in which this may happen.
Novice investors should be aware that the capital gains on share investments can, potentially, be taxed as income if the South African Revenue Service believes the investor is trading in shares for purposes of making a profit (i.e. a profit-making scheme) instead of for purposes of holding them as income-producing investment. The difference between the two is very small and the intention, among other things, of the investor when buying and selling these shares, plays a large part in determining how they will be taxed.
Most investors – particularly those who have committed themselves to long-term wealth accumulation – are likely to not find themselves in this position. Instead, they will be liable for Capital Gains Tax (CGT). CGT is a lower tax rate than income tax – so it's advantageous to investors. In South Africa, individual share investors pay marginal (income) tax on 33.3% of all capital gains. (If  you are at the top marginal tax rate of 40%, that equals an effective 13.3% CGT tax rate.)
We advise you to consult your tax adviser before making any investment decisions.

Understanding some rudimentary accounting isn't just for accountants – all investors should have some basic accounting knowledge that will help them in the share-picking process. The good news is that it is easier than you think.

There are three main financial statements that investors should read in the annual report:

• The balance sheet gives a "snapshot" of a company's financial position on a particular day. That snapshot shows the company's assets, liabilities and its net asset value (assets minus liabilities).
• The income statement's purpose is to show a company's profit (or earnings or net income or bottom line). Profit is the amount of money that's left over once all expenses (including operating costs, interest payments and tax) have been subtracted from sales.
• The cash flow statement shows all receipts and payments of cash and the company's cash position at year-end.

Investors can also find important extra information in the statement of changes in equity and the value-added statement. Don't forget to read the notes to the financial statements – they contain the detail you need to evaluate the balance sheet, income statement and cash flow statement.

For novice investors it can seem strange that a R100 share can be cheaper than a R10 share. The reason is that investors use a number of ratios to determine one share's value relative to another.

Here are three common investment ratios:

• The price: earnings (p:e) ratio is the most common investment ratio. It tells you how many rand you are paying for each rand of earnings.
• The price: book ratio shows whether the market has factored a company's asset value (on its balance sheet) into its share price.
• The price: sales ratio is the share price divided by sales per share.

One share is cheaper than another when its relevant investment ratio is cheaper than that of the second share.

The dividend yield is the dividend per share divided by the share price. The share with the highest dividend yield is the cheapest, all other things being equal. Shareholders can compare this to how much money they will earn if they put their cash into a money market account, remembering that dividends are tax-free whereas interest (above a threshold) is not.

Markets go through different stages – or cycles – even though the long-term trend has been for share prices to appreciate.

All markets are cyclical: they increase, peak, fall and then bottom. Market cycles are more important for traders than long-term investors who leave their money in the market for longer than a complete cycle.

Typically there are four phases in a market cycle. The first, or accumulation, phase occurs once a stock market has reached the bottom of the last cycle. However, most investors don't recognize this as the beginning of a new upward cycle so only very astute and experienced investors enter the market at this stage. Though valuations are attractive, market sentiment remains bearish (negative) and then, slowly, turns neutral. In the mark-up phase, share prices begin to increase as more investors realise that the cycle has turned. During the distribution phase, sellers begin to dominate. The market's bullish (positive) sentiment becomes mixed and prices can be range-bound. This third phase can be short or long, but it inevitably gives way to the final stage of the cycle. The mark-down phase is the last stage of the investment cycle.

Ironically most die-hard investors, who have held onto their stocks as prices crumble, will sell just as the market reaches its bottom.

There are variations within this simplistic framework as investor sentiment can stretch market cycles to extremes such as bull markets, bubbles, crashes, corrections and bear markets.

• In a bull market, positive investor sentiment drives share prices higher.
• Corrections are where share prices retrace some of their gains.
• A bear market occurs where share prices continue to fall for some time after a correction.
• Over-inflated stock market bubbles may be ended by crashes, where share prices fall sharply in a short period. The good news is that the share prices of the corporate survivors of these crashes do recover.

The secret to successful investing is discipline, not luck. There are some basic trading rules that everyone – from novice to guru – can use to minimise losses and maximise investment gains.

There are five possible outcomes from buying stocks: a big profit, a big loss, a small profit, a small loss and breakeven. Successful investing means avoiding those big losses.

Here are some pointers to help you do that:

• Never put money into the market that you can not afford to lose.
• Use stop-losses to help prevent losses in trading. Do your own homework before you commit your money to an investment.
• Set realistic expectations.