A stock is defined as a share of ownership of a publicly-traded company that is traded on a stock exchange. Common stocks are securities, sold to the public, that constitute an ownership stake in a corporation. They come in all sizes -- you can invest in a large, global company, like IBM (IBM) , or a smaller, micro-cap company that shows potential for profit.
When you buy a share of a stock, you automatically own a percentage of the firm, and an ownership stake of its assets. If you paid $100 for a share of stock, and the stock appreciates in value by, say, 10% during the period you own it, you've earned $10 on your stock investment.
That's the idea behind buying stocks -- to invest in solid, well-managed companies that turn a profit. A company that succeeds on those fronts stands a good chance of its stock price growing in value, while the company, in going public, makes use of the proceeds of the original stock sale to reach growth goals and manage operating expenses. The company can use the cash to invest in new markets, research new products, hire more workers and better advertise their products and services, among other things.
In most cases, it doesn't take much effort to buy stock shares and own a piece of a company. You would simply pay what the market is demanding (market price) for a particular stock, via a stockbroker either over the phone or via a digital device, and you're good to go. You'll receive confirmation of your purchase and can sell the stock whenever you like, hopefully for a profit.
As a partial company owner, being a stockholder presents perks --including sharing in company profits, voting on a company's board of directors and approving major changes at a firm, like a merger or an acquisition.
What is the Stock Market?
There really isn't just one single stock market -- there are many stock markets around the world, although the most well-known include the New York Stock Exchange (NYSE), Nasdaq, and the London Stock Exchange (LSE).
Stock markets are public trading venues that enable investors of all stripes to buy, sell and issue stocks on an exchange, or via over-the-counter (OTC) trading. An OTC market is "A decentralized market, without a central physical location, where market participants trade with one another through various communication modes such as the telephone, email and proprietary electronic trading systems." according to Investopedia.
A fair, open and efficient stock market is vital to the proper trading of stocks around the world -- to the publicly-traded companies whose stocks are traded, and to the investors who buy and sell stocks. Companies gain access to capital by issuing stocks, and investors have a place to safely and accurately trade securities.
The stock market also has indexes that track the performance of a specific group of stocks. For example, the Dow Jones Industrial Average is the price-weighted average of 30 of the largest companies in the world, including 3M (MMM) , Disney (DIS) , and Exxon (XOM) .
Stock indexes provide investors with a capsule to look at a specific group of stocks at a single time. Chances are, if the Dow Jones Industrial average is "up" for the day, then the entire stock market is generally up, as well.
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The days of relying on a traditional stockbroker are largely going away. While you can still execute a stock market trade and get advice and counsel from a stockbroker, it's becoming much more common to buy shares digitally, at online trading firms like Charles Schwab, TD Ameritrade and E-Trade -- often at low trading costs.
Origins of Stock Trading
The origins of stocks and the stock market go back to the 11th century, when French businessmen traded agricultural debts on a brokerage exchange. Stock trading picked up speed in the 13th century, when Venice merchants began trading government securities. Antwerp, Belgium is widely credited with having the first stock exchange, launched back in the 1400s.
The first-ever publicly-traded stock was the East India Company, which began trading in the early 1600s. Investors didn't have to take a risky sea-going journey to capitalize on the lucrative East Indies trade market. Instead, they could buy shares in the East India Company. The venture proved so successful that soon after, stocks began trading all across Europe.
The first major stock exchange was the London Stock Exchange, which opened in 1698. The New York Stock Exchange officially opened for trading in 1817, although the founders first began trading securities in New York under the Buttonwood Agreement, which was signed in 1792.
Types of Stocks
There are multiple forms of publicly traded stocks, but the most pervasive are common stocks and preferred stocks.
A common stock is the most widely-traded form of stocks. A share of common stocks gives the shareholder one share of stock, and one vote (per share owned) at company shareholder events. Besides profiting from any rise in value, stockholders may also be eligible to receive dividend payments from the company whose stock they own. Typically, larger, better-established companies are most likely to pay dividends, as they have more assets on hand than newer, growing companies. (See more on dividend stocks below.)
Preferred stock is a form of ownership in a company which generally has priority over common stockholders on earnings and assets in the event of liquidation. In other words, if the company goes bankrupt, preferred stock dividends are paid after the company's debt but before dividends on the company's common stock.
In general, stocks increase in value by:
- Increasing in price.
- Generating income in the form of dividends.
Dividends represent profits earned by a company that are passed on to shareholders. When a company like Disney or Exxon has a good financial quarter, they'll reward shareholders with a dividend. The dividend can be increased or decreased as a company sees fit.
Why Would You Buy Shares of Stock?
Investors buy stocks primarily to make a profit. But that said, it's not the only reason to buy stocks. Let's look at the most common reasons people buy stocks in the stock market:
- To make money. When stocks appreciate in value and are worth more than the investor paid to buy the stock, that's a positive outcome for investors.
- To earn dividend payments. When a publicly-traded company pays out dividends to shareholders, that adds value (and income) for the shareholder.
- To gain influence at a company. Stock market shareholders have the ability to vote on company matters and key issues.
- To outflank inflation. Inflation eats into income. Thus, making money on stocks helps investors stay ahead of inflation.
- To save for retirement and other long-term financial objectives. Since stocks appreciate over time, much more so than bonds or bank deposits, they are a great tool for investors looking to save for the long-haul -- especially for retirement.
Why Would You Sell Shares of Stock?
Once you buy a stock, you have the ability to sell it whenever you like. Under what conditions would you normally sell a stock? These factors come into consideration:
- To make a profit. You buy a stock for $10 per share and six months later, it's worth $20 per share. That's a good reason to sell stocks -- to make a profit.
- The stock represents too much risk. Often, people sell stocks to reduce risk. For example, if shares have grown so much that the stock represents a major portion of an investor's portfolio, an investor may sell some or all of those shares to reduce that risk and create a more-balanced, or diversified, portfolio.
- You are worried about the company. Sometimes, company fundamentals change and you don't have the same positive outlook you had on the stock when you bought it. It could be a scandal at the company, a new CEO, or bad news on the financial front. Each could be enough for someone to sell their stock.
- You need the money. If you have short-term cash needs -- paying for a child's college tuition, buying a home, or starting a business, for example -- selling a stock can give you an immediate cash infusion.
- You like another stock better. Often, investors sell shares of stock so they have the cash to buy another stock that they believe offers better value.
What Does a Stock Price Mean?
A stock price is the absolute measure of a company's worth to investors. For most investors, the goal is to "buy low and sell high." In that regard, a stock price also represents what other investors will pay to buy a stock at a specific time. That's why indexes track stock prices so closely -- they give investors the price other investors recently paid to buy a stock and provide a financial framework to ascertain a stock's worth and value.
Stock market participants and investment industry professionals also use a stock price to mark the financial health of a publicly traded company.
There isn't actually a direct connection between a stock's price and the financial outlook for a company. But earnings releases and other financial news generally have a relatively direct impact on stock prices. So stock prices do paint a picture of how a company is doing financially, and are thus regarded as a big factor in evaluating a company when you're considering adding it to your portfolio.
Stock prices are also an accurate gauge of investors' confidence in a company. When a stock is rising, that means investors have strong confidence in a company. When a stock price is in decline, that means investors are losing confidence in a company.
A Tried-and-True Investment Vehicle
Stocks are a historically-proven way to make a financial profit, and rank well ahead of other securities in terms of performance returns.
Yet like any other financial venture, the return you get on stocks is largely dependent on the work you put into researching stocks.
Basically, the more you learn, the more you earn.