Most people at some point in their life will hear about stocks and the stock market. They can provide people with a chance to grow their money and reach their investment goals. But, what exactly are they though? They certainly are more than just flashing numbers on a screen.
At the most basic level, stocks, or shares of a company, represent ownership. If a person buys even one single stock, he becomes a shareholder who owns a percentage of that corporation. This ownership percentage is calculated by dividing the number of stocks a person owns by the outstanding shares, which is the total number of stocks the company has. For example, if someone has ten stocks in a company that has a total of 100 shares, he or she owns 10% of that company. Companies initially do not participate in the sale of stocks until they “go public,” meaning they enable any potential investor to buy and trade their stocks. The event in which they go public is called an IPO, and they happen a lot. A business may decide to go public in order to bring more money into the company, often with the purpose of expansion.
Common and Preferred Shares
There are different types of stocks that give the owner varying levels of privilege or control in the corporation. Common stock generally allows the shareholder to vote on matters of corporate policy and on who gets placed on the board of directors. Preferred stock owners usually do not have the power to vote on company matters, but they do have a higher priority on assets, things that the business owns, and earnings, the profits of a company, meaning they get paid their share of earnings before common stockholders.
Companies have a finite amount of stock but always are able to issue (release) more shares to the public in order to raise more capital. When new stocks are issued, the current shareholders see their ownership diluted, meaning they own proportionally less of the company. If a company initially has 100 shares but decides to issue 100 more, a person who owns ten stocks would see the percent of the company that he or she owns decrease from 10% (10/100) to 5% (10/200).
Depending on the company, shareholders might receive dividends, or payments proportional to the profits of the business. Dividends are often seen as a guaranteed return on a stock and companies agree to give them out to incentivize investors to buy their stock.
The Stock Market
To understand stocks, you must first understand what the stock market is.
The stock market is a place in which buyers, sellers, and brokers interact to buy and sell monetary vehicles such as stocks. However, when we refer to the stock market, we are often referring to U.S.-based stock exchanges, such as the NYSE (New York Stock Exchange) that you may often see on TV, with an expansive trading floor, and many stockbrokers running around frantically. Stockbrokers are people who take orders to buy or sell stocks from investors and find someone who’d either be willing to buy or sell that stock. The NASDAQ is also a U.S.-based exchange, but it is all virtual and made up of a series of servers that are housed in Carteret, New Jersey. Regardless of the type of stock exchange, each serves the same purpose – to facilitate the buying and selling of stocks, bonds, and other assets.
The History of Stock Markets
The way in which stocks are exchanged in an exchange has changed drastically over the past 400 years with the growing use of technology to facilitate liquidity and volume. The very first stock exchange, the Amsterdam Stock Exchange, as well as other early stock exchanges, were located in bazaars or open-air markets, in which buyers and sellers of stocks would shout across the room to make transactions. The CME (as I discussed earlier) started as an open-air market in which butter and egg futures contracts were traded. In the 1960s, digital marketplaces became commonplace for stock exchanges.
Investing in Stocks
As there are many companies that do not pay regular dividends to their shareholders, the question “why buy stocks?” seems a valid one. And the answer to it is a simple concept: trading. Not trading in the sense of directly exchanging one share for another, but rather in the sense of buying and selling stocks. The goal of investing in the stock market is to buy low and sell high. You always want to sell something higher than the price you bought that thing at, and the same idea applies to the stock market.
An investor wants to add shares to his or her portfolio, which is the collection of stocks and other investments the investor has made, at as cheap a cost as possible, and then be able to sell those shares at a higher price. The profit an investor earns from the sale of his stocks goes into his own pocket, allowing him to either buy more stocks or cash out from the market completely. Now, the phrase “buy low” does not mean that any low-priced stock is a good buy. A person should look for stocks in companies that have the potential to increase in value so that they will be worth more at a later time, i.e. when the investor will want to sell.
A stock’s price increases or decreases depending on the company it represents and the expectations surrounding that company’s future. If a company seems to be expanding and becoming more successful, more people will want to buy its stock. This increases the demand for all of that company’s shares and, as a result, the price for each one increases. On the contrary, if the business is on a downward trend, its stocks will be harder for the current shareholders to sell and ultimately will have to decrease in value in order to be sold.
The stock market is a very complex entity and there are countless factors that influence valuations and determine what is or is not a good buy. Hopefully, this introduction to the stock market will give you the foundation to learn more about investing and the ability to understand all of its ins and outs!
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