What Are Stocks and How Do They Work?

Learning about what stocks are and how they work is essential to achieving strong investment returns and will allow for significant financial advantage.

Investing your money wisely is extremely important to achieving monetary success and attaining financial goals. Chances are, if you have, or are working on creating an investment strategy, it likely includes stocks of some form. The historical performance of the stock market is what renders this investment type so popular. Between 1930 and 2013 the S&P 500 index produced an average return of 9.7%. Although this includes some extremely rough years as well as some exceptional years, this high average return for investing in stocks makes a solid case for owning them.

Even though stocks have proven to be a valuable investment that can provide a great return, you might be asking “how does the stock market work?”

Investing in the stock market may seem like a daunting task, but once the concepts are learnt and the right practices are implemented, the rewards are significant. And although there are many vehicles for which to gain exposure to stocks, such as mutual funds and ETFs, which require no actually stock picking on the investors part, it is still essential to understand how investing in stocks works to have the upper hand when it comes to investing.

So, Exactly What Are Stocks?

Stocks are equity investments that represent ownership in a company. Stocks can also go by the name of “shares” or “equities” which essentially mean you are a (part) business owner. Purchasing company stock comes with certain rights which may include receiving a dividend as well as voting rights at shareholder meetings.

Companies issue shares as a means to raise large amounts of capital. This capital is then used to fund different projects that will ultimately lead to growth and create a return for investors. A company can go from private to public through the issuance of an initial public offering(IPO). When a company decides to go public, they must also chose 1-4 unique letters (depending on the exchange they are listed on) for unique identification (known as the stock ticker symbol). Sometimes, companies can even get creative when it comes to choosing their ticker symbols.

The stock price of a company that has gone public is simply the market’s determination of the company’s value. That value is dependent on its assets, its current profits, and its expected future profits amongst other things. Although the process of raising capital through stock offerings is a great means for a company to achieve rapid growth and expansion, there are also downsides as well. Aside from the high fees paid to be listed on an exchange, public companies must disclose their financial reports, abide by certain regulations and face constant pressure and scrutiny from shareholders.

Types of Stocks

There are two main types of stocks widely available for purchase: common stock and preferred stock. Common stock offers you a piece of a company along with voting rights. With common stock, you are aiming for capital gains along with the collection of dividends, although there is no obligation for companies to pay common shareholders a dividend. A dividend is a cash disbursement of some of their earnings back to shareholders, or, a kind of reward for investing.

Preferred stock, however, works a little differently. For one thing, you probably won’t get a vote with your share. In exchange for voting rights, preferred stock guarantees you more access to financial advantages. Such as, if a company is going to pay a dividend, it is going to pay its preferred stockholders first. Common stocks are generally riskier than preferred stocks. It is recommended to have a good mix between common and preferred shares in your portfolio, depending on your investment strategy.

Although these are the two most common types of stocks, it is also possible for companies to customize different classes of stock in any way they want. Using this type of stock classification is usually due to a company wanting the voting power to remain with a certain group of people (such as the case with Facebook). This can be done by offering more votes to a certain class of stock over another. When there is more than one class of stock, the classes are typically designed as Class A and Class B. For example, Warren Buffet’s Berkshire Hathaway offers both Class A (BRK.A) and Class B (BRK.B) stock.

How Stocks Work: 10 Things To Know Before Buying Stocks

So, how do stocks work? Below is a long list of random things to know about stocks. Introduce a number of the other intro to stocks articles with links to the full descriptions

1. Learn the language

   Wall Street can confuse you if you haven’t learned the language of investing. Learn the differences and the meaning between buy and hold, investing and day trading, how to trade stock options, market timing strategies and more.

2. Learn the basics

   Understanding the stock market basics is not a natural skill, but a learned one. It goes without saying, learning the basics is an essential step to getting started in the stock market. Find the right beginner stock market trading technique and training that stimulates you. Most importantly, never think you’ve learnt it all.

3. Practice

   Play stock market games, this will help you train using fake money and thereby getting real experience, without any of the risk. You know what they say, practice makes perfect – or when it comes to investing, practice creates returns.

4. Focus on the long-term

   Being lured by the excitement of day trading often creates unwanted stress and early losses for the new investor. A buy and hold strategy, made famous by investing legend Warren Buffet, may be less exciting, however, it delivers solid profits over the long-term.

5. Minimize risk

   While there are many techniques that affect your stock market investing odds, this is the one overriding key to improve your total investment return. You can never eliminate all risk, but a course like Creating an Investment Strategy will help you learn strategies that minimize risk, particularly the unnecessary variety.

6. Leverage the experts

   There are many experts out there with decades of experience under their belt that you can turn to for help, like this list of financial gurus. In the digital age, nothing is too far out of reach. Connect with them on social pages and research what investment strategies they are using. Also, stay away from those sites that charge you for their stock picks. If they were really that good at picking stocks, they wouldn’t need your money.

7. Know your investor profile

   You might be asking yourself, “what are the best stocks to invest in?” Well, the answer to this question depends on your investor profile, e.g. how much risk can you tolerate. Even better, how much risk can you afford to take. You may find that equities are too risky for your portfolio. Or maybe stocks are suitable for you but you’re better off staying with the big blue chip companies. This is extremely important in order to avoid ending up in a vulnerable position

8. Diversification is key

   And a critical component of successful investing and long-term profits. Through diversification, creating your stock portfolio with a wide variety of securities from different companies, industries, and geographical areas, you can significantly decrease your risk quotient.

9. Keep up with the news

   Pick up the financial section of a newspaper, check out a finance-focused website, or subscribe to a newsletter. This doesn’t mean check-in on the markets at every moment of the day. Rather, have an idea of important current micro and macro economic events. Knowing what is happening will put you in a much better position to create a successful portfolio.

10. Know when to hold’em

    And know when to fold them. And no, you are not gambling.

Investing in the stock market is not a trip but a journey. There are always more lessons to be learnt, strategies to discover and money to be made. Buying stocks is not a gamble but an investment. It is not a pastime but a commitment. To be truly successful, hard work and dedication is crucial. The stock market encompasses a world where patience is rewarded and composure breeds success. Qualities like discipline, emotional control, persistence, and focus will flourish as investing experience is earned. But above all, a commitment to learned-investing breads a lifetime of improved finances