Modern Americans have grown up hearing about stocks on the news every night and reading about them in the newspapers every morning.
With all of this exposure to stocks and the stock market, it is easy to feel as if everyone knows what stocks are and how they work. For many new investors, however, getting started with stock market investment can be a little more complicated than expected.
Fortunately, investing in the stock market does not have to be difficult. Potential investors can equip themselves to succeed by learning a few basic but essential terms and ideas. Once new investors familiarize themselves with the types of stocks available to them, the types of markets they may find themselves trading in and how to buy and sell stocks to their best advantage, they will be ready to begin trading with confidence.
When companies are created they are generally wholly and privately owned by their founders. Sometimes, a privately-owned company decides that it needs or wants to raise capital for growth or expansion. One of the ways it can do that is by issuing stocks. Stocks are legal rights to a portion of a company’s profits. To issue stocks, a privately-owned company holds an initial public offering (IPO). The IPO offers investors an opportunity to purchase stocks, which are shares of the company’s profit. Once a company has sold its first stocks, it transforms from a privately held company into a publicly traded one.
Stocks are sometimes casually referred to as shares of ownership in a company. Technically, that is not accurate. Stocks are only associated with a right to a company’s profits. They do not entitle a stockholder to the company’s assets, such as buildings or equipment. Buying and holding stock in a company does entitle an investor to exert a small amount of influence on the company’s decisions. Investors can exercise that right by voting on decisions or issues at annual shareholders’ meetings. The more stock an investor holds in a company, the more weight his or her votes carry.
Stocks create value for investors in two ways. First, companies may pay stockholders yearly dividends. Dividends are portions of operating profits divided up amongst and paid out to shareholders by a company. Second, stocks may appreciate in value. This usually happens when a company is growing or experiencing other publicly recognized success, which attracts new investors to purchase stocks. To acquire stock in the desired company, investors must buy shares from existing stockholders. The demand for stock increases the price of the shares. That, in turn, raises the value of the stocks existing shareholders already own. Stockholders may hold onto their shares, which may continue to increase in price, or choose sell their stocks at the new, higher price and enjoy the profits.
Most of the stocks investors can buy are known as common stocks. Financial advisors sometimes caution new investors that common stocks are considered a relatively high-risk investment. This is because dividends are not guaranteed. Some stocks do not pay dividends even when the company turns a profit. If a company’s stock value falls, investors’ holdings can significantly drop in value. In the event that the company fails, stockholders are at the end of list of parties to receive compensation. Often, they receive no reimbursement for their lost investments. The upside to these risks is the equally high rate of return most stocks offer when the company is successful and the market is strong. Stockholders can and often do make large amounts of money on their common stock investments.
In addition to common stocks, companies may also issue preferred stocks. Preferred stocks are, in effect, a hybrid of common stocks and bonds. They reduce investors’ risks, but also reduce their potential profits by the same degree. Instead of offering a high-risk and high-reward scenario like common stocks, preferred stocks typically promise stockholders a set return each year for the life of the stock. Investors will receive the same payout annually, regardless of what profits or losses the company experiences. Holders of preferred stocks often do not have voting rights. Preferred stocks may also be recalled by the company at any time. If preferred stock is recalled, stockholders must sell their shares back to the company for a fair value or better. Preferred stock holders may also receive priority over common stock holders for compensation in the event that a company folds.
Less commonly, companies may elect to issue special classes of stock. Each class of stock is assigned a different level of voting power. For example, one class may come with twenty votes per share. The next may have ten votes per share while the class beneath that receives only five votes per share. This style of stock creation and issuance allows companies to better control and manage stockholders’ voting power.Buying and Selling Stocks
Investors may purchase stocks directly from companies during IPOs. This is called buying from a primary market. They can also buy them from other investors through an exchange. This is referred to as buying from a secondary market. Most stock purchases and sales take place through secondary markets. Stock exchanges may be physical places or entirely digital. In either case, they serve as a meeting point for investors who wish to buy or sell stocks.
Stocks do not have a single set price and there is no oversight agency directly controlling or setting stocks’ prices. Stock prices may be indirectly influenced by a company’s decisions or health, the health of the economy overall, and prevailing attitude among investors at any given time. A “bull market” is said to be in effect when the economy is good, stock prices are rising and investors’ attitudes are primarily positive. A “bear market” is when the economy is sluggish, stock prices are stagnant or dropping and investors are wary or negative about the potential for growth and recovery.
There are many major stock exchanges in the world. Stock exchanges are often linked to one another, which increases the speed and efficiency of purchases and sales across nations and regions. All major stock exchanges are carefully governed, to ensure fair and legal trades. These exchanges deal only in shares of businesses which have been rigorously vetted and judged to be suitably stable.
Smaller, less well governed exchanges, which may be referred to as over-the-counter exchanges or bulletin boards, allow investors to trade in higher-risk stocks. These might include shares of companies that are too new or too small to qualify for larger exchanges, or companies in industries too volatile to meet the stability requirements of mainstream exchanges.
Investors can buy and sell stock in real time or may automate their transactions. For example, an investor might set up an authorization under which he automatically buys shares of Company A whenever they become available at a certain price threshold. Alternatively, he might arrange to automatically sell his shares of Company B if the price increases and he is able to net a certain amount per share. Investors can use a variety of tools to help them make their own stock investment decisions. Or, for a fee, they can entrust their investing decisions to a qualified professional who will take responsibility for growing and managing their assets.