What Are Stocks and How Do They Work?
Last Updated: January 11, 2023
The global stock market value stands at $80 trillion, and it’s continuously growing with no signs of slowing down. Stocks offer great investment opportunities and as such, stock markets can be quite competitive. If you want to dive into the stock market and grow your money, you need to arrive prepared.
So what are stocks and how do they work?
That’s what we’ll be discussing in this article. We will explore the basics and then go into how you can invest in stocks.
If you want to know more about stock investment, grab your favorite drink or snack and settle in.
It’s time to learn everything you need to know about stocks and trading them.
What Is a Stock?
The first thing you need to know is what stocks are. Often, newcomers to the stock market and trading get confused by ‘stocks’ and ‘shares.’
A stock can be bought on the stock market — it can be sold at a later point when the price of the stock has increased, or it can be kept indefinitely. Dividend stocks pay out dividends, so they’re the kind of stock you usually hold on to.
Right, now you know what a stock is. So, what are shares of stocks? Often, people think stocks and shares are the same thing, and they’re almost right.
Shares of stocks represent the stockholder’s ownership of a company or corporation. Companies are divided into units so that many people can buy and own a small part of them.
A ‘stock’ is the general and more generic term used to describe a person’s slice of ownership of more than one company. A ‘share’, on the other hand, is more specific — this refers to the partial ownership of one company.
You would use ‘stocks’ when referring to your entire investment portfolio and ‘shares’ when listing the specific companies that you invested in.
How Do Stocks Work?
Having stock means you’ve bought shares from a range of companies that caught your fancy.
There are two main types: common stock and preferred stock. This kind of stock determines your investment in a company. Owners of preferred stock have higher priority should a company go bust.
As the name suggests, common stock is the most commonly found type and is usually the kind of stock beginner investors go for. You can buy single shares if you don’t feel like investing too much money at once. There are other stock types as well, but we’ll get into that a little later on in the article.
What Is Initial Public Offering (IPO)?
An initial public offering is the very first sale of stocks issued by a company. Before a company can start to trade stocks on the stock market, it will have to make an initial offering.
While the company decides the number of shares it will offer, an investment bank will decide on the initial price. This price will be influenced by a prediction of demand for the stock.
When stocks’ a company undertakes an IPO, the primary reason to issue stock is usually funding.
These companies also benefit from the boost it gives their public profile.
Investing in this kind of stock can pay off well, but it’s also somewhat risky as the stock value can fluctuate wildly.
Now, you may be wondering how many shares does a company have, and is there a limit?
There is no restriction on how many shares a company may have, so it depends on what the owners decide.
A new company will usually have only a few shares — between 10 and 100 to a thousand — while larger companies can have millions. The company owners will determine the number of shares to issue by looking at its future growth expectations.
Different Stock Types
Understanding how stocks work requires understanding what stocks are, what your stock options are, and what owning them entails. To help you understand, we’ve listed the various types of stock you’ll find on stock exchanges such as NASDAQ.
These are seen as the most reliable stocks and represent partial ownership in a company. They come with considerable risk but a lot of gain, which is what makes common stocks so popular.
Preferred stocks give their owners priority over common shareholders. So, if the company goes down, preferred stock shareholders will be first in line to get their money back. These stocks and shares are not as easy to find as common stocks.
These stocks can be bought from companies in the country where you live. Buying stock from domestic companies is ideal for beginner stock buyers because no foreign currencies are involved.
You will find international stocks are found on the international stock market. This allows investors to buy stock from the British market, the Japanese market, the American market, and more.
Dividend stocks regularly issue dividend payments to shareholders. Companies selling shares that pay out this way are a favorite with investors who are buying stock to have a regular income.
There are no regular payouts with these stocks, so the money goes right back into the company. This leads to the value of its stock rising, which results in more profit for investors.
These are the same as dividend stocks and pay out in the form of dividends. You’ll find them available from companies that are established and don’t have many long-term growth opportunities.
ESG (Environmental, Social, and Governance) stocks have to meet requirements and are ideal for investors with stocks and investments aimed at bettering the world. The conditions are related to the company’s impact on the environment.
Safe stocks’ share prices make small up and down movements on the stock market and aren’t deeply affected by economic changes.
Companies usually fall into one of three related categories: small-cap, mid-cap, and large-cap. Small-cap stocks can be bought from companies with market caps below $2 billion and are riskier than the other two stock options.
The companies with mid-cap stocks have market caps that are between $2 billion and $10 billion. They are also risky but have adequate future growth capacity, making single stocks return from them worth the trouble.
To offer large-cap stocks, a company must have a market capitalization of $10 billion and above. Buying stock from these companies is considered safer with a low risk of losing your money.
Companies that are growing quickly and showing impressive sales and profits can offer investors growth stocks. Usually, these stocks are risky and inexpensive but with great potential.
You can buy cyclical stocks from companies that operate in industries that sell services or products in demand when the economy performs well. Companies selling shares like this include restaurants, airlines, and hotels.
Non-cyclical stocks are also called defensive or secular stocks. They come from companies that don’t have many fluctuations in demand, such as retailers.
These stocks are less risky and can be bought from well-known, mature companies. They are reliable, so owning stock from these companies is considered a valuable and safe investment.
Penny stocks’ worth is determined through perceived quality. These stocks can be bought from small, low-quality companies and are very risky.
Initial Public Offering stocks are exciting and ideal for investors looking to support new companies. Because the companies are still young, these stocks are often high-risk.
Blue-chip stocks are available from industry leaders and are some of the safest stock options. Although the returns aren’t always high, they’re very stable and relatively risk-free.
How Stocks Work — 7 Things You Need To Know Before Investing
This stocks article aims to be informative and prepare you for your adventure in stock investment.
The stock market can be quite intimidating; learning about stock investment shouldn’t have to be.
Stocks are about money for both the investor and the company. The main reason companies issue stock is to get money from people who believe it is worth investing in.
Companies sell shares to improve their worth and public profile. The value of a share of stock depends on supply and demand. If a company has a good reputation and growing sales, people will want to invest.
Owning stocks gives the investor a chance to get money back periodically or profit when reselling the stock.
So, if you’re wondering, ‘are stocks a good investment?’, the answer is it can be, as long as you’re informed about stocks and how they work. You have to research the company you’re looking to buy stock from. You also have to know a few basics before getting started.
Let’s look at those basics:
The Stock Market Isn’t (Likely) Going To Make You Millions
We’ve all heard of investors who became millionaires almost overnight through trading stocks. While stocks are an excellent investment, the stock market isn’t a money-making machine.
It is possible to make good money through stock exchanges but don’t have unrealistic expectations. Stocks ownership will pay off if you have good knowledge of stock markets and make smart decisions. It certainly won’t happen overnight.
Many people have lost large sums of money through stock trading, so always approach this form of investment with care.
Stock Trading Can Be Very Risky
Part of our quest to answer ‘what are stocks and how do they work?’ is to realize that it’s not a get-rich-quick scheme.
It can be less risky than relying on a lottery ticket to bring in money, but it’s not completely risk-free. Investment in stocks becomes safer the more you know about it, and the longer you’ve been doing it.
Buying stock is often seen as a safe long-term investment. However, nothing is ever truly guaranteed, and the stock market is unpredictable, especially in the short-term.
As such, owning stock isn’t an ideal short-term plan. It’s much safer and more profitable if done with long-term goals in mind.
Pay Attention To a Company’s Earnings Growth
If you want to determine if a company is a good investment, examine its earnings growth trends. How do the company’s earnings increase over time? If there is good, steady growth, the company might offer an impressive stock benefit to investors. If not, you should consider another company.
You should do all you can to understand how the company works; evaluate its cost structure, competitive advantages and disadvantages, cash flow sustainability, target market, and market opportunity. All these factors will indicate whether or not you should be buying shares in the company.
Consider Using a Stockbroker
You can get active on the stock market with the help of a stockbroker. You can also use a brokerage, which can easily be found online.
Buying stock through a brokerage is quite simple – you open an account, deposit money, and the brokerage will purchase shares for you. Most brokerages ask for a small fee, but the single stock return (if you’re not interested in spending too much) makes up for that.
Each brokerage has its strengths and weaknesses, and you’ll have to look closely at your options before choosing one. Avoid investing all your money through one stockbroker. It can be risky to trust your entire investment plan to one brokerage or stockbroker.
Only Invest Your Surplus Funds
It can be tempting to invest as much money as possible in many different companies. This could be a mistake, though. If you’re putting all your eggs in one basket, you risk losing them all, as the saying goes.
The thing about stocks and investing is that it can be incredibly risky but also promises great rewards. If your investment pays off, you can reap amazing rewards, but you can lose everything you invested if things go wrong.
Having stocks in more than one promising company is a much safer strategy than ‘going all in’ with a single company.
You can also consider buying single stocks from a range of companies for a more diverse investment portfolio.
Compare Companies to Their Peers
If you’re unsure of which companies will be suitable investments, you should look at where the company stands in its industry. This kind of valuation is beneficial when you’re thinking of buying stocks.
How does the company compare against its competition? Does it have any advantages or an ‘edge’ over its competitors?
Look at the growth of sales of the company as well as its earnings. Choose a period and compare the company’s overall performance to that of its peers. Does it look like investing in this company will pay off over time? What kind of stock benefit can you expect?
Don’t Get Emotional with Stocks and Investments
When it comes to investing your money, you should never let your emotions impact your decisions. Learn to separate your emotions from investing, don’t buy shares just because you like the company or its founders, employees, etc.
Fear and greed are emotions as well, and it’s never a good idea to be a slave to these feelings. To be successful on the stock exchanges, you have to remain cool, calm, and collected.
Why You Should Invest In Stocks
If you’re new to stock trading, you might ask yourself, ‘why do people buy stocks?’. Of course, the obvious reason is that it’s a way to make more money.
People approach companies selling stocks because owning stocks is lucrative. Stock trading can also be thrilling and exciting, depending on how you approach it. Alternatively, investors who seek stable investment will find there are stock types that cater to their needs.
If you’re not yet convinced that buying buying shares of stock is a good idea, here are a few more reasons why you should consider stock investment:
Stocks Work Well With a Growing Economy
Buying shares help to keep economies growing ever bigger. Corporate earnings increase as the economy grows. The growth is stimulated by jobs that are created, which results in increased incomes. More income means more sales. It’s a healthy cycle that creates a breeding ground for stocks and investments.
Buying and Selling Shares of Stock Is Easy
Investment through stocks is not as difficult as other forms of investment might be. If you can find the right brokerage or have the proper stock market knowledge, it’s easy to buy shares.
With that said, how does buying stock work exactly? You can sell your shares whenever you want. There are no requirements that need to be met before you can sell the stock you’ve bought.
Stay Ahead of Inflation
Stocks have an average annual return of 10%, which is better than the average yearly inflation rate. With shares, you get to stay ahead of inflation. You just have to keep your stock for longer to ensure that you get your money’s worth from buying stocks.
Make Double the Money
Buying buying shares of stock can lead you to make money in two ways: you can resell the stock when it is worth more or earn dividends paid regularly.
How to Invest in Stocks?
By now, you know the various types of stock and how to approach this kind of investment. Let’s look at what you need to do to get started.
First off, you’ll start by determining how much money you have to invest. Then, you have to do some research and find companies that are worth investing in.
After that, you need to approach a stockbroker or brokerage with good knowledge on how stocks work and start investing.
Your shares will be profitable in one of two ways: you can either get paid dividends regularly or resell the shares at a later time when they’re worth more money.
All this sounds very easy, but investing in stocks can take a lot of time before it’s worth your dedication and effort. It’s not as simple as finding a stockbroker and throwing your money at companies.
If you choose right, this form of investment can be very lucrative and rewarding. However, you can lose everything if things don’t go as hoped and expected.
If you’re unsure of exactly how to get started, several reliable online stockbrokers can help you. They know all about stocks and how to make sure you make as much money as possible.
You are likely keen to get started by now, and we suggest you make use of automated investment solutions.
There are several great investing platforms that will help you get started with buying shares quickly and effortlessly.
Using these platforms can help you take the mystery out of stock investment and help you answer the often asked question: What are stocks and how do they work? Of course, this article also helps a lot so you can be more confident in approaching these platforms.
Best trading platforms
Some of the best options are:
Wealthfront offers a diversified portfolio that can be adjusted to your risk preferences and dynamic planning to help you reach your financial goals. You can withdraw your money without paying any fees and get access to a high-interest Wealthfront checking account.
You can enjoy peace of mind when buying all types of shares of stocks through Roofstock because you get a 30-day money-back guarantee. Its fees are low, and you can invest in out-of-state properties with more ease.
With Betterment, there is no initial investment amount required, so you can start approaching companies without money in your account. There are many investment options, and Betterment’s portfolios are flexible.
You don’t have to be an accredited investor to start buying stocks with RealtyMogul. The return rates are reasonable, and passive asset allocation makes investing a lot simpler.
- Worthy Bonds
Although you need a minimum balance of $10 to get started with Worthy Bonds, the round-up feature makes money contribution easier. This is a good option for investors who want short-term gains and need lower single stocks risk.
Ellevest comes at an affordable price and is a professional private wealth management service. It is focused on helping women invest, which makes it unique. You get access to financial advice to get you started successfully.
- Ally Invest
Ally Invest charges no commission for some stocks, and the contract fee is low. As such, this is an excellent choice for investors with tight budgets. It also offers free research tools and market analysis.
- M1 Finance
As one of the most popular automated investing platforms, M1 Finance is easy to use and offers intelligent automation of stocks ownership and trading. The complete portfolio customization and affordable fee for extra benefits add to its appeal.
Fundrise offers investment decisions made by a team of financial advisors, not a robo-advisory service. It has a low minimum investment requirement and makes property investment much more manageable.
You should now have a good idea of what to expect in the stock trading world. There are many benefits to owning stock, but it can take a lot of patience and determination to find the right companies to invest in.
Fortunately, there are many useful tools and brokerages that are happy to help investors find the best opportunities.
You don’t have to do much to earn money from your stock ownership. Once you’ve purchased your shares, you can wait until they are worth more than you paid and sell them. Or, you can invest in dividend stocks that pay out dividends regularly.
The first method takes a keen eye to determine the right time to sell. Investment in dividend stocks is more relaxed, and you only have to ‘work’ once when you find the right company to invest in.
In short? The same way it does for everyone else. The stock market is just a place where investors buy shares in companies that are listed on the market.
Buyers place bids on stocks, and sellers announce their asking prices. When the offer is equal to the asking price, a trade takes place. Stock prices are heavily influenced by supply and demand.
Getting started in stock investment can seem like a daunting task, but when you’ve taken the time to do proper research, you’ll find it less intimidating.
So how do stocks work? Once you buy stock, you own a small part of a company. You won’t buy yourself a seat at the boardroom table, but there are other benefits to stock ownership.
Dividend shares will pay investors for each share they have, and the more the company grows, the more money investors receive.
You can decide to take the money or reinvest in the company. If you didn’t invest in a company that pays out dividends, you might want to sell your shares when they are worth more than you initially paid. It can sometimes take long before the share has increased in value, though.
Stocks are often confused with shares, though they are very similar. Stocks are a collection of the shares you have purchased from companies. Shares are the units of a company that are for sale on the stock market.
Stock trading is a form of investment that is trusted by billions of people all over the world. This article has covered many aspects of stocks; you’ve reached the end and learned a lot, so be proud of yourself. Next time someone asks ‘what are stocks and how do they work?’, you should be able to explain it to them quite well!