Published on 29 Dec 2015 in Educational program, Bonds, Portfolio
If the very thought of investing your money in the stock market (aka the stock market) scares you, you are not alone. False promises and widely publicized stories about investors who hit the jackpot or, conversely, lost everything, distort the average investor’s view of the real state of affairs. But if you start to understand a little better about the stock market and how it works, you will most likely realize that it is not as scary as it might seem at first glance, and that it can become a reliable haven for your investments.
What is a stock?
By buying a share, you are acquiring part of the company. When a company needs to raise money, it issues shares. This is done through an initial public offering (IPO), in which the price of a share is set based on the assessed value of the company, as well as how many shares it issues. The company receives money that allows it to develop its business, the shares continue to trade on the stock market.
Traders and investors continue to buy and sell shares of the company on the stock market, although the company itself no longer receives any funds from this type of trading. The company only receives money from the IPO.
Why Buy Stocks?
Traders and investors continue to trade the company’s shares after the IPO, as the subjective value of the company changes over time. Investors can make or lose money depending on whether their views are in line with the “market” ones. The market is the mass of investors and traders who buy and sell stocks, thereby moving prices up or down.
It is extremely difficult to make predictions about which stocks will rise or fall in price, and when exactly. Over time, stocks generally show an upward trend. This is why investors choose to buy a basket of securities in different sectors (this is called diversification) and stick to them. Investors using this approach are not worried about momentary fluctuations in stock prices. The ultimate goal of buying stocks is to make money by buying stocks in companies that you think will be doing well, companies whose subjective value (in the form of the stock price) will rise.
Mature and well-established companies can pay dividends, or interest on shares, to their shareholders. A dividend is a portion of a company’s profits that the company directs to shareholders. Unlike a dividend, the share price will continue to fluctuate; losses and gains associated with the share price are independent of the dividend. Dividends can be large or small – or they may not exist at all (many shares do not pay dividends). Investors who want to receive a regular income from investing in the stock market prefer to buy stocks rather than pay high dividends.
By purchasing shares in a company, you become the owner of a part of this company and, accordingly, get the right to vote on its management. Although there are different classes of shares (a company can issue shares more than once), as a rule, owning shares gives you voting rights corresponding to the number of shares you own. Shareholders, as a group of people voting individually, elect the board of directors and can vote on major decisions the company makes.
Why Sell Shares?
Every stock trade has a seller and a buyer. When you buy a stake, someone has to sell it to you. Either the buyer or the seller can be aggressive, thereby pushing the price up or down.
When the price of a stock falls, sellers are more aggressive because they are willing to sell at lower and lower prices. Buyers are also shy and willing to buy at lower and lower prices. The price will continue to fall until it reaches the point where buyers enter the game and become more aggressive and willing to buy at a higher price, thereby driving up the price.
Investors don’t have a single agenda, so traders sell stocks at different times. One investor can hold on to stocks that have risen substantially and then sell them to lock in that profit and get cash. Another trader bought shares at a higher price than what they are selling for now, which puts him at a disadvantage. This trader can sell the stock so that his losses do not become even more significant. In addition, investors and traders can sell stocks out of their belief that they will fall in price in order to collect their money before this happens.
The number of shares that will change owners in one day is called the volume of exchange trades. Millions of shares are traded on large exchanges like the NYSE or NASDAQ. This means that, in theory, thousands of investors in the same company could decide to sell its shares on the same day. Stocks that boast significant daily trading volume are attractive to investors as it means they can easily sell or buy stocks whenever they want.
When the volume of exchange trading is recognized as insufficient, or when no one is actively trading the stocks you are interested in, it is still possible to get rid of a small number of them, since the exchange rules stipulate that certain traders (firms) must provide volume. These traders are called market makers. They act as buyers and sellers when there are no buyers and sellers on the exchange. However, they do not need to stop prices from falling or rising, which is why most investors and traders choose to trade high volume stocks and do not rely on these market makers, which are now predominantly electronic and automated. There are also live people on the exchanges. These men and women in blue jackets are trading stock for their firms.
Shares are issued by companies to raise money, after which the shares continue to trade on the exchange. Over the long term, stocks rise in value, making it attractive to own. In addition, there are additional bonuses – dividends (income), profit prospects and voting rights. However, the share price may also decline. That is why investors invest in a variety of stocks, risking only a small percentage of their capital on each. Shares can be bought or sold at any time, provided there is enough trading volume to complete the transaction. This means that investors can cut losses or reap profits whenever they want.
A source: Investopedia.com.
Did you like the article? Share it with your friends on social networks!
Also in this heading: