How Do Stocks Work?
Are you looking to invest your money but aren’t quite sure how stocks work? For the past ten years, the stock exchanges have been experiencing a bull market with a global market cap of a record $95 trillion. While the market is good, investing in stocks can be a very wise investment for your money, savings, and retirement plan.
We’ll discuss key points about how stocks work, how the stock market works, and how to begin investing in stocks to take advantage of the current bull market.
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What are Stocks?
Stocks, or equities, represent ownership shares of a publicly-traded company. By buying a stock, you now own a small part of that business. As a shareholder, you will share in the business’s success through monetary compensation as the company performs well.
When a private company “goes public,” the company is opening up to become a public company where anyone can buy ownership of the business through buying stocks.
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How Do Stocks Work?
To raise capital, businesses go public and sell a set number of shares on a stock exchange. Businesses raise capital to fund the growth of their business and expand sales and operations. When a company first lists on a stock exchange, this is called an initial public offering (IPO).
Investors can then buy and sell the company’s stocks through the exchange. Investors use stockbrokers and financial planners to purchase stocks through the exchange. There are several brokerages online that facilitate this process.
Once an investor buys a stock, they can wait to sell the stock. As a company performs well, its stock price hopefully increases. Some companies also pay dividends per stock when they have a high-performing year. Dividends boost your investment without having to sell the stock.
Different Types of Stocks
There are about 19 major types of stocks, but the majority of stocks traded are common stock or preferred stock. Common stocks are public stocks that allow you to have partial ownership of the company. Common stock is easy to buy and sell, but the investor generally doesn’t get anything if the company fails.
Preferred Stock must pay a certain amount to the investor if the company fails. Preferred stock also pays dividends to the investor when the company has a good year. These types of stock are generally not publicly traded but are offered to company employees.
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How Do Beginners Buy Stocks?
Buying stock is not a complicated process and can even be set up within twenty minutes. Setting up an account with a stockbroker, you’ll want to:
- Research, select, and set up an account with an online stock brokerage. Several competing companies offer a variety of benefits and options. You’ll want to find a brokerage service that best meets your investment strategy needs. Many offer brokerage services through an app on your mobile device, making buying and selling stocks very convenient.
- Research the stocks to buy. While buying the stock is easy, knowing which stocks will be the best investment can be difficult to discern without extensive research, analysis, and monitoring.
- Determine how many shares you want to buy. You may want to buy a specific number or have only a specific amount of money to spend. This will depend on your situation. If you want to invest in some of the leading stocks with ridiculously high stock prices, you can buy a fractional stock that now gives you a percentage of a single share without the hefty investment.
- Select your order type. When first beginning, you will generally select a market order or a limit order. A market order specifies that you are buying or selling at the best current market price.
A limit order establishes the stock price that you want to wait for before buying or selling. Limit orders traditionally can have higher commission fees because it may take several transactions to complete the order.
- Diversify your stock portfolio to maximize earnings. When you invest you should consider a variety of stocks in different sectors. This way if a specific sector doesn’t perform well, you investment in other stocks can stablize your portfolio.
Diversifying allows you to weather and benefit from the swings and volatility of the stock market. You may want to consider investing in cryptocurrencies, which trade similarly to stocks and other securities.
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Benefits of Buying Stocks
Buying stocks is a great way to invest your money. By putting your money into stocks, you can:
- Profit from a growing economy. When the economy is doing well, businesses enjoy higher earnings, creating jobs, income, and sales that bolster the stock price and increase your investment earnings.
- Enjoy a higher annualized return of around 10% for long-term investments. Increasing your investment by 10% is better than the inflation rate and traditional bank interest rate.
- Buy stocks easily through online accounts, a broker, or a financial planner. Setting up an account is relatively easy and often offers low to free commissions, making stock purchasing more accessible.
- Provide different investment strategies. Stock investors always want to buy low and sell stocks at a higher price. Some investors prefer to buy and sell stocks daily for quick returns, while other investors prefer to buy and hold stocks that will pay significant returns over time. The beauty of the stock market is that you can do both types of investing to diversify.
- Sell stocks quickly and easily. Because the exchanges and brokerages make buying and selling stocks very convenient, stocks are a very liquid investment, allowing you to access your money if you need it quickly.
Risks of Buying Stocks
While buying stocks is a wise investment, it isn’t without risks. There are some inherent risks of owning stocks:
- Stock prices can be volatile. Even stocks from established companies can have a bad quarter that can affect their stock price. And market conditions can also sway and tank stock prices even when a company is performing well. If you don’t watch your investment, you could lose it all.
- Stockholders are the last to be paid. If a company experiences bankruptcy, preferred stockholders and creditors are paid before stockholders. You’ll want to follow your stock’s financials and sell before it gets to bankruptcy.
- Stock Investing requires lots of research and time to find the best and most profitable stocks. Then once you’ve bought the stocks, you’ll want to monitor, analyze, and determine the best time to sell these stocks, whether it is short-term or long-term.
- Owning stocks can play with your emotions. Because stock prices can shift erratically, it can be difficult to watch and experience. When prices rise, you’ll be elated. But when prices drop, it can be devastating.
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Stock Market Basics
A stock market facilitates the buying and selling of stocks between:
- Institutional investors
- Individual investors
When you buy stock through a broker, you are purchasing stocks that another investor is selling. The stock market encompasses different sectors, stock exchanges, and stock market indexes.
Stock Market Sectors
The stock market is divided into different sectors. Each stock market sector is a collection of businesses that are in similar industries. Currently, there are eleven stock market sectors uses to classify publicly traded businesses based on the Global Industry Classification Standard (GICS):
- Communication Services
- Consumer Discretionary
- Consumer Staples
- Information Technology
- Real Estate
When a company goes public, it is categorized within a stock market sector based on its business model and industry. Some sectors are more volatile than others. That’s why it is essential to buy stocks from various sectors to reduce the risk of wiping out your investment.
Stock Exchanges are where people buy and sell shares in a common market space. When a company goes public, they choose a stock exchange and pay to be a part of the exchange’s list of available stocks. The exchanges become a one-stop-shop for investors to buy and sell stock. The most common stock exchanges are:
- The New York Stock Exchange (NYSE): the largest exchange in the world
- The Nasdaq Stock Exchange: the second-largest exchange
- OTC Markets
Stock Market Indexes
A stock market index gives investors a snapshot of how a sector or an economy is performing by collecting, analyzing, and communicating data from various companies across industries. Indexes allow investors to watch how the overall market, a sector, or a country’s economy is shifting and tracking over time.
The most popular stock market indexes are:
- Dow Jones Industrial Average (DJIA): This index tracks 30 of the largest US businesses.
- Standard & Poor 500 (S&P 500): This index follows the performance of 500 companies and is a good indicator of the overall stock market.
- Nasdaq Composite Index: This index follows 3,000 companies that are predominately in the technology sector.
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What Determines a Stock’s Price on a Stock Market?
Supply and demand determine a stock’s price. Companies limit the number of stocks available for purchase. So when a company performs well, investors will pay for stocks based on availability.
If investors want to keep their stocks in the company, then the price of the stock will rise based on scarcity. If a company performs poorly, investors may be motivated to sell their stocks, which will increase availability and drop the price of the stock.
What is a Bull Market?
A bull market occurs when a financial market has rising prices, or the prices are expected to rise. While most investors refer to the overall stock market, you can also use the term bull market in reference to a particular sector, stock, bond, currency, or commodity. If a stock is bullish, it is doing well or expected to do well.
Indexes are excellent indicators of how the overall market is doing and help determine if the stock market is a bull or bear market.
What is a Bear Market?
A bear market is the opposite of a bull market. A bear market indicates that the overall market is experiencing declining prices over a prolonged amount of time. When stock prices fall 20% or more, then it is considered a bear market.
How investors feel about the market overall can also affect a downward turn of stock prices. If investors worry about the economy, then stock prices can drop across sectors, creating a bear market.
Investing in Stocks is a Wise Way to Grow Your Money
If you are willing to do the research and can handle volatility, then you may want to invest in stocks. While the economy and stock market continue to charge ahead, you’ll want to find stocks that will diversify and support your investment strategy, whether that’s short term investments, long-term, or both.
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