Stock Basics
Understanding the stock market starts
with understanding stocks. A stock represents partial ownership of a
company – the smallest share possible. Company's issues stocks
to raise capital and investors who buy stock are actually buying a portion
of the company. Ownership, even a small share, gives investors rights
to a say in how the company is run and a share in the profits (if any).
While stocks give owners certain rights, they do not carry obligation
in case the company defaults or faces a lawsuit. In a worst-case scenario
the stock will become worthless but that is the limit to the investor's
liability.
Companies issue stocks to raise capital.
They may need a cash injection to expand or to acquire new properties.
Each stock issue is limited to a certain number of shares, and when
they are issued they are given a par value. The market quickly adjusts
that par value according the perceived health of the company and its
potential for growth.
Investors usually buy stocks because they
believe the company will continue to grow and the value of their shares
will rise accordingly. Investors who acquire stock in a new company
are taking more of a risk than buying shares of well-established companies
but the potential gain is much greater. Those who bought Microsoft shares
early in the game (and did not sell them) saw an exponential rise in
their value.
Stock trading is done on stock exchanges
like the New York Stock Exchange (NYSE) or NASDAQ (National Association
of Securities Dealers Automated Quotation System). This means that only
companies listed on a public exchange have shares that can be bought
and sold on the open market. Of course, you could also buy partial ownership
in a smaller company that is not listed on a stock exchange but that
is a very different type of investment than buying stocks.
Because stocks must be bought and sold
on a stock exchange, an individual investor needs a broker to make transactions
for him. Brokers take orders to buy or sell a certain stock. The order
may include instructions to trade at a certain price or simply what
the market will bear. Once the broker receives the order he attempts
to execute it by finding a buyer or seller as the case may be. The buyer
or seller is also represented by a broker and each broker receives a
commission on the sale.
Stocks have several advantages over savings
investments. Because they represent ownership in a company they give
the holder rights to participate in major decisions the company faces.
Every share represents one vote and shareholders are regularly asked
to vote on important matters. Ownership also allows stockholders to
benefit from any profits the company makes. Profits are distributed
in the form of dividends, and may be issued once or twice a year at
the discretion of the company directors.
If the company prospers the value of the
stock will rise and distribution of profits also increases. The downside
of this is that if the company does poorly the value of the stocks may
fall.
When compared with savings investments
(like bonds or bank certificates of deposit) stocks have the potential
to earn more money -- but they also carry the risk of loss. Learning
about the stock market and the various investment strategies can help
to minimize loss, and most investors find they do much better on the
stock market than is possible with any kind of savings investment.
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