Stock market for beginners: from A to Z
To explain stocks and shares for beginners, we have to start by figuring out what the stock market really is. The definition of a stock market can be easily explained as a “place” where a person can buy, sell or trade stocks (also called shares) of publicly held companies. It can also be referred to as an equity market or stock exchange.
As an essential part of the global economy, the stock market provides interested investors and companies with the opportunity and possibility to transact capital in order to achieve a definite level of legitimate ownership. While being called a stock market, it provides more than just equity trading. It also involves other financial securities and derivatives that are based on various currencies, bonds and commodities.
A stock price is based on a company’s earnings. If a business is doing well, its stock price goes up; if it is performing poorly, its price tends to go down. The stock market also relies on the condition of the overall global economy.
Types of stocks
Basically, stocks fall into two categories – common and preferred.
Common stock – A security that serves as ownership in a company. It gives you a right to own a piece of the business while not taking any possession. This means common stockholders are usually considered to be on the bottom of the priority list when it comes to receiving any of the company’s assets in any unforeseen situations.
Preferred stock – A share of ownership in a public company that provides its owner with a higher claim on business’ earnings and assets than common stock. That’s where this stock’s name is derived – being “preferred” over the common shares in a company to receive dividends and assets in the event of liquidation.
Another main difference between these two is that, unlike preferred stocks, common stocks give voting rights to its shareholder (e.g. participation in various corporate actions).
It should be noted that, in the stock market, the cost of a share for both common and preferred stock can vary depending on the company’s earnings and overall performance.
That’s how the stock market works
How does the stock market really work? The idea behind how the stock market functions is pretty simple. The concept of it might remind you of an auction – it allows sellers and buyers to communicate, bargain and make trades.
The stock market operates through a network of traditional exchanges, such as the NASDAQ or NYSE, and over-the-counter (OTC) marketplaces, whose popularity has remarkably increased over the past few years.
Once a business decides to raise money for its development and expansion, it announces itself as ‘going public’ – making an Initial Public Offering (also known as an IPO) of its common stock. The company usually puts a small portion of its ownership up for sale. The cost is mainly set based on the value of the entire company. Investors are the ones to purchase these shares and can continuously resell it among other interested parties.
To keep the stock market working, trade must keep flowing. Sellers and buyers trade current and previously issued stocks. “Previously issued” stocks are those which, when traded, don’t tend to have much of an impact on the company’s operations or performance.
Businesses that are listed on the exchanges aren’t buying or selling their own shares on a daily basis. They rarely participate in stock buybacks or the issuing of new shares. It is important to understand that, when buying a share on the stock market, you are purchasing it not from the company itself but from another shareholder. Same goes vice versa – once you sell your shares, you are giving it away to other investors, not back to the company from which it was issued.
Buyers offer the highest amount that they are willing to pay (bid). Frequently, it is a lower price than sellers ask for. That gap between these sums is called the “bid-ask spread”. One side of the trade tends to increase or decrease the stated price. Liquidity of the stock depends on this price spread: the narrower the spread and the bigger the number of shares on each side, the greater the liquidity is.
The exchange tracks the supply and demand of all listed stocks. This information helps formulate the price for each security and track the levels at which trading participants are eager to sell or buy it. Nowadays, those calculations are done by computer algorithms. There are plenty of metrics and ratios that can be implemented to value stocks. One of the most popular used in the stock market is considered to be the Price/Earnings ratio. Analysis of a stock is also generally divided into two types: technical or fundamental analysis.
Why invest in the stock markets?
First of all, the stock market allows companies to generate much-needed capital that can be used to fund their businesses. Issuing a share on the stock market instead of borrowing the money helps prevent the company from debt and further payments of interest charges for them. A strong performance in the stock market also allows the company to acquire other firms with stocks and shares instead of doing so with money. Additionally, some companies’ owners may seek the status and prestige that come with a publicly traded business.
The second purpose is the opportunity for investors to get a share in the company’s profits. With the way that stock market works, investors are able to win in one of two different ways: receiving regular dividends from the stock or reselling the share they earlier bought if the price increases.
It can be easily said that investing in the stock market is one of the most accessible ways for people to build wealth and gain exposure to the modern world of finance. Online stock trading becomes more and more popular worldwide.
Appropriate stock investments will help to keep pace with ongoing inflation, provide financial flexibility and tax advantages, and offer portfolio diversity. Some individual investors will also have the ability to participate in the company’s operations and contribute to its development.
However, everyone involved in stock trading or investing needs to keep in mind that unfortunately, nobody has a magic crystal ball to predict the future, especially when it comes to the world of economics. As a matter of fact, stock prices do change over time, and it is important to know some techniques and strategies that can keep you on the safe side. At the end of the day, if there is a way to make money while you sleep by investing in stocks, it is definitely worth trying.
To learn more about the stock market and find comprehensive information on stock trading for beginners, check out free online courses and trading guides provided by Capital.com.