Market Basics
The stock market may appear daunting at times, but it is a system that has proven to be effective and accessible for all types of investors. Think of it like an auction. Buyers and sellers are matched by the auctioneer to arrive at transactions that are agreeable to both parties. It operates on the basic premise of supply and demand – there are no fixed prices; rather, prices are set based on what buyers are willing to pay and sellers are willing to take. The same is true of the stock market, but instead of physical objects, buyers and sellers trade shares of stock.
Stocks
So what is stock? When you own a share of stock in a company, you own a small fraction of the corporation. When the company profits, you may profit as well, and when the company struggles financially, your investment may struggle too. In addition, shares of common stock come with voting rights, meaning that in addition to owning part of the company, you have a say in some decisions made by the company. The more shares you own, the stronger your voice in company matters. Holders of preferred stock do not have voting rights.
When you buy a share of stock, there is a paper certificate issued to you by the company. Investors used to physically keep these certificates, and some still do, but in today’s electronic age, most brokerage firms hold the certificates in their own name on your behalf so that they can execute your trading orders more efficiently.
Stock Exchanges
Stocks in publicly traded companies are bought and sold at a stock market (or stock exchange). Stock exchanges operate like auction houses in the above example. They are marketplaces in which buyers and sellers come together to trade securities. The NASDAQ and New York Stock Exchange (NYSE) are examples of stock exchanges.
The exchange makes buying and selling easy. You use a stock broker (like Scottrade) who does business with the exchange. You can buy and sell shares because your broker represents you on the exchange and facilitates your transactions.
Because most stock buying and selling occurs in one place (the exchange), it allows the price of a stock to be known every second of the day. Therefore, you can watch as a stock’s price fluctuates based on news, economic events, media reports, etc.
Historically, stock trading was done in person at a physical exchange. Now, some exchanges like the NYSE still offer this option, but also allow trades to be made electronically. NASDAQ, on the other hand, is a completely electronic system where trades are placed via an extensive computerized network.
Publicly Traded Companies
Corporations issue shares of their stock to the public to raise capital for growth and operating costs.
In a simplified example, say a company sells 1 million shares of stock at $50 a share. This raises $50 million in capital very quickly. The company then invests the $50 million back into the company (equipment, assets, employees, etc). The investors (or people that bought the shares) hope that the company will make a profit, meaning the stock price will increase.
When a corporation is publicly traded, all of its financial information is available to the public. The Securities and Exchange Commission (SEC) collects this information and makes it available to investors. When investors are trying to decide whether to invest in a particular company, they use a number of indicators (company financial information, historical performance, expectations for the future, etc.) to determine how much a stock is worth and whether it is something they want to buy.