Understanding the stock market starts with understanding stocks. A stock represents partial ownership of a company – the smallest share possible. Company’s issues stocks to raise capital and investors who buy stock are actually buying a portion of the company.
Ownership, even a small share, gives investors rights to a say in how the company is run and a share in the profits (if any). While stocks give owners certain rights, they do not carry obligation in case the company defaults or faces a lawsuit. In a worst-case scenario the stock will become worthless but that is the limit to the investor’s liability.
Companies issue stocks to raise capital. They may need a cash injection to expand or to acquire new properties. Each stock issue is limited to a certain number of shares, and when they are issued they are given a par value. The market quickly adjusts that par value according the perceived health of the company and its potential for growth.
Investors usually buy stocks because they believe the company will continue to grow and the value of their shares will rise accordingly. Investors who acquire stock in a new company are taking more of a risk than buying shares of well-established companies but the potential gain is much greater. Those who bought Microsoft shares early in the game (and did not sell them) saw an exponential rise in their value.
Stock trading is done on stock exchanges like the New York Stock Exchange (NYSE) or NASDAQ (National Association of Securities Dealers Automated Quotation System). This means that only companies listed on a public exchange have shares that can be bought and sold on the open market.
Of course, you could also buy partial ownership in a smaller company that is not listed on a stock exchange but that is a very different type of investment than buying stocks. Because stocks must be bought and sold on a stock exchange, an individual investor needs a broker to make transactions for him. Brokers take orders to buy or sell a certain stock.
The order may include instructions to trade at a certain price or simply what the market will bear. Once the broker receives the order he attempts to execute it by finding a buyer or seller as the case may be. The buyer or seller is also represented by a broker and each broker receives a commission on the sale.
Stocks have several advantages over savings investments. Because they represent ownership in a company they give the holder rights to participate in major decisions the company faces. Every share represents one vote and shareholders are regularly asked to vote on important matters. Ownership also allows stockholders to benefit from any profits the company makes. Profits are distributed in the form of dividends, and may be issued once or twice a year at the discretion of the company directors.
If the company prospers the value of the stock will rise and distribution of profits also increases. The downside of this is that if the company does poorly the value of the stocks may fall.
When compared with savings investments (like bonds or bank certificates of deposit) stocks have the potential to earn more money — but they also carry the risk of loss. Learning about the stock market and the various investment strategies can help to minimize loss, and most investors find they do much better on the stock market than is possible with any kind of savings investment.