Education

Stock Market

Stock markets and the idea of trading stock can appear as quite an overwhelming task for the uninitiated, and understandably so. However, when armed with a general and basic understanding of how buying and selling shares works, you may find it can become a lucrative way of generating income.

A Basic Definition

stock companies

Obviously, in order to comprehend the more complex features of stock markets, it is first necessary to gain a general understanding of the more basic aspects of investing in stocks. The most logical starting point is to ask the simple question: what is a stock? A basic answer is that a stock, or a share, is a very small percentage of a company. When you purchase a company’s stock, you are, in fact, purchasing a fractionally small portion of said company. A company will begin selling shares if they need to generate money in order to stay afloat, or to grow as a business. Purchasing an individual share of a company’s stock is equivocal to owning a small percentage of the company.

The price of any share varies largely from company to company and is determined by estimating a company’s value, and how many shares are going to be sold during an Initial Public Offering (IPO). An IPO is the time at which a company will determine the price of its shares and begin selling them to investors. Once the company has initially sold the stock, it will no longer make any financial gain on those particular shares. The company earns money during the IPO only, regardless of how much their stock is traded afterwards. So with this definition of stocks considered, a stock market can be interpreted as an accumulation of all of the buyers and sellers of stock. This trading of stock can be done with publically-listed stocks, and stocks that are just available privately. Companies choose to list their stock for sale in a stock exchange of their choice. A stock exchange is an exchange where stocks and other securities are bought and sold. Larger companies tend to list their stock in exchanges in several different countries in order to increase the potential for international investment.

 Who Trades on a Stock Market?

stock exchange

When you have acquired a basic definition of stocks and stock markets, it is then useful to understand who trades stock. The simple answer is anyone and everyone. Participants in the buying and selling of stock range from individuals who trade for their own personal gain, to institutional investors, to corporations who are buying and selling their own shares. Individual traders, also known as retail investors, trade stock on a stock market for their own personal account, not for another larger institution. Unsurprisingly, retail investors tend to trade in much smaller volumes of stock than the larger public corporations and institutional investors. The Investment Company Institute and the Securities Industry Association reported that over 50 million households in the USA are currently involved in some form of retail investing.

The next key demographic of traders on stock markets are institutional investors. In contrast to retail investors, institutional investors trades much larger quantities of shares, and amounts of money. Institutional investors are organisations that invest for the benefit of their members. Common examples of institutional investors include, but are not limited to banks, hedge funds, pensions, insurance companies, mutual funds, and endowments. Because of the large volume and prices of shares traded by institutional investors, they are permitted to pay lower commissions on trades, and are subject to less stringent protective regulations in the stock market. The final common type of trader found in stock markets is the publically traded corporation, trading in its own stock. Recently, markets have been described as more “institutionalised” as financial institutions, institutional investors, and investor groups make up the largest portion of traders. This is in comparison to several decades ago when individual investors represented a more significant portion of all traders of stock.

 Why Invest in Stock?

It is important to grasp the main reasons investors buy shares, or invest in stocks. As a share’s market value continues to fluctuate following IPO, traders will buy and sell this stock in order to maximise financial gain. As the market buys and sells stock, the price of specific shares will rise and fall due to the varying levels of demand. The primary goal when buying shares is to predict when their market price will rise or fall, so the trader can purchase the stock when the price is at its lowest, and sell when it is highest. However, this is not a straightforward process and market price fluctuations can be very difficult to predict. Generally speaking, stocks tend to experience an overall increase in value over time. As a result, traders often invest in a large and varied collection of stock (diversification), which they will then hold for a long time as the price gradually rises. Essentially, traders will invest in stock if they think its market price will experience a rise, meaning they can then sell it to earn a profit.

Another reason for investing in stock is the potential to be paid dividends from the company whose stock you have purchased. A dividend is a small portion of a company’s profit which is distributed amongst its shareholders, based on what percentage of shares they own. These dividends are paid independently of the company’s stock market value and, as a result, investors tend to favour companies that pay high dividends, as they can guarantee a fixed amount of money for their investment regardless of the stock’s price fluctuations on the market.

Conversely, traders may sell stock if the price has risen drastically and they wish to cash in on their investment. Similarly, if a stock’s market price begins to fall, a trader may wish to sell it in order to minimise the potential loss from their investment. Previous research and analysis may lead an investor to believe that the price of their stock is set to drop, and as a result they may sell.

Conclusion

The information included in this article is merely the tip of the iceberg when it comes to fully understanding stock markets. However, the basic understanding of stock markets provided should present you with the necessary tools to begin considering a potential future investing in stocks and trading on a stock market.