Many of us have heard about the stock market and that it is a place where a lot of money can be made or lost, but what exactly is it? And how does it work? The following article is a very basic introduction to the stock market, how it works, and how to get started.
In order to explain what it means to invest in stocks, we must first define what a “stock” is. Essentially, a “stock” is a portion of a publicly traded company that is available to the public for purchase. Stocks are commonly referred to as “shares”. Shares of a company are only available for sale if it is a public company. Private companies on the other hand, are not available for sale on a stock exchange.
So what makes a company Public and what makes a company private? A private company is one that is owned and operated by an individual, group of people or a legal entity and is directed and guided by its owners. A public company is one that is owned by a large variety of people (shareholders) and is operated by a board of directors and executive team. These directors and executives are guided by the influence of the shareholders. It is called a public company because shares of it are available for sale to the public via a stock exchange. All companies begin as private companies and some, for a variety of reasons, make the transition to become a public company. When a private company decides that it wants to make this transition and is approved to do so by the SEC (Securities and Exchange Commission) a Stock Market advisory board, they enter the market place through a process called an “Initial Public Offering” or IPO. When a company makes an IPO, that company is essentially telling the world that it is for sale and anyone who is eligible can buy portions of it.
Since the shareholders of a company of the key influencers of the direction of its activities, most of the original owners or founders of a new public company save large portions of the stock so that they remain majority shareholders. This way, they maintain power and influence as majority shareholders of the company. After a company’s IPO, these shares are actively traded on a stock exchange, which is a open, secondary marketplace to BUY and SELL shares in a public company.
How do people make money by Buying and Selling shares? When you invest in the stock market, you can make money through realized capital gains and dividends. Similarly you can lose money through realized capital losses. Capital gains in reference to investing in the stock market is when a company’s market price increases from one price point to another higher price point in a given period of time. Therefore, if you buy a share of Google Stock (NASDAQ: GOOG) at $800 and the next day the price increase to $850, then you have a gain of $50. But remember this value is still an unrealized gain. This means that while the value of your stock has increased, you haven’t yet secured this value. In order to fully secure this gain and make it a realized gain, you would have to sell you share(s), thus freezing the opportunity for your share(s) to move higher or lower in price.
This also works in the opposite direction; a company’s price has the possibility to go up or down. If Google’s stock that you bought went down the next day to $750, this is an unrealized loss. This money has a chance of recovering and increasing back up to $800 because it is Google stock and this is a company that is performing well, however this isn’t the case with all companies. There are many companies whose shares can decrease in price and not recover. This is where realized loss comes in. If a company’s shares start to decrease in market price and do not recover to the original market price or goes bankrupt before you get the change to sell that stock, then the capital loss becomes a realized capital loss.
To learn more about why a stock’s prices change, check out this GOOD BUSINESS article on Price Action.
A second way for people to make money with stocks is through dividends. A dividend is a percentage of the current market price of a company share and is issued to shareholders by the company each quarter. However, while it is very common to issue dividends, not all companies do this. Dividends are more or less a “gift” from the company to the shareholders for having the confidence to invest in the company and to make up for limited gain potentials due to stable price action. (If the stock doesn’t move up and down in large degrees, then it is difficult to exploit the capital gains or losses).
Dividends are valued through an established rate by the company, known as a dividend yield. (This is calculated: Annual Dividends per Share / Price per Share). This rate is posted with most stocks price listings and is used as an added incentive for investors to choose to buy a company’s stock. Generally companies with high growth will not issue dividends, so that they can reinvest this capital for further sustained growth.
Basic Strategy: The general rule is to BUY a stock when it is low and SELL a stock when it is high. The key is timing, this means finding the right time to buy or sell a company’s stock to maximize profits and minimize losses. If you see that a company’s stock is increasing over a period of time, you may want to buy shares in that stock if you think that the stock price will go higher that the price that you buy it at (Capital Gains). Similarly, if you see a company’s stock is decreasing you may see this as a good time to buy, because it could be a bargain price. Or not. As explained above, sometimes a company’s stock price will decrease and then recover and increase (thus maximizing capital gains), but sometimes not, a company’s stock has the chance of never recovering or stagnating at a certain price for an extended period of time. This price action depends on a variety of factors, namely the company profile and its operations, as well as the current and future market conditions.
This is what makes investing in the stock market challenging. It takes time to research each company that you would like to invest in and then make an educated decision of whether to buy or sell a stock.
To assist you in your research, there is a large array of resources that is available to help you learn more about individual companies, market sectors and regional markets.
For great industry news and financial evaluations, I recommend the following websites:
- Bloomberg Report:
- Bloomberg Business Week:
- Economist – Business & Finance:
- Fast Company:
- Google Finance:
To learn more about evaluating stocks, read Arber Doci’s GOOD BUSINESS article on Stock Valuations.
By now, you may be asking, how do you actually buy or sell these shares of publicly traded companies? In order for an individual to buy or sell stocks, they must utilize a stock brokerage company. This is a company who employs stock brokers who are licensed to buy or sell stocks in a given market. This company also holds your money in an account, like a bank so that it is available for buying and selling when you choose to complete a transaction.
For great Brokerage Companies with strong reputations, I recommend the following firms:
NOTE: To all investors, especially if you are just starting out, I recommend reading more about the Four Golden Rules of investing, read my latest article here: The Golden Rules of Investing.
If you have any questions or comments at all, please feel free to comment here.