How the stock market works


For a new investor, the stock market can feel a lot like legalized gambling, as a short-term investment vehicle that either brings huge monetary gains or devastating losses. But remember, the more you learn about stocks, and the more you understand the true nature of stock market investment, the better and smarter you’ll manage your money.

The stock market can be intimidating, but a little information can help ease your fears.

Let’s start with some basic definitions. A share of stock is literally a share in the ownership of a company. When you buy a share of stock, you’re entitled to a small fraction of the assets and earnings of that company. Assets include everything the company owns (buildings, equipment, trademarks), and earnings are all of the money the company brings in from selling its products and services.

Why would a company want to share its assets and earnings with the general public? Because it needs the money, of course. By selling stock, the company gets money with fewer strings attached. There is no interest to pay and no requirement to even pay the money back at all. Even better, equity financing distributes the risk of doing business among a large pool of investors (stockholders). If the company fails, the founders don’t lose all of their money; they lose several thousand smaller chunks of other people’s money.

Stocks in publicly traded companies are bought and sold at a stock market (also known as a stock exchange). The New York Stock Exchange (NYSE) is an example of stock market. In your neighborhood, you have a “supermarket” that sells food. The reason you go the supermarket is because you can go to one place and buy all of the different types of food that you need in one stop

-It’s a lot more convenient than driving around to the butcher, the dairy farmer and the baker. The NYSE is a supermarket for stocks. The NYSE can be thought of as a big room where everyone who wants to buy and sell shares of stocks can go to buy and sell.
You can call a stock broker who does business with the NYSE, or you can buy and sell stocks online for a small fee.
There are three big stock exchanges in the United States:

-NYSE – New York Stock Exchange

-AMEX – American Stock Exchange

-NASDAQ – National Association of Securities Dealers

Any business that wants to sell shares of stock to private or public investors needs to become a corporation first. A corporation is a “virtual person.” That is, a corporation is registered with the government, has its own Social Security number, can own property, sue and make contracts. (It can also be sued.) By definition, a corporation has stock that can be bought and sold; all of the owners of the corporation hold shares of stock in the corporation to represent their ownership.

Shareholders are the people who own shares of stock in a company. Collectively, the shareholders are the owners of the company, since each share of stock entitles the owner to a say in how the corporation is run. Shareholders elect a board of directors to make the company’s major decisions, such as the number of shares to be issued to the public.
Interestingly, not all corporations decide to have public shareholders. Corporations can choose to be privately or publicly held.

Stock prices aren’t fixed. From the second a stock is sold to the public, its price will rise and fall based on free market forces. The key to investing is “buy low, sell high.
A much riskier investment strategy is to try to pick the “next big thing” and cash out quickly after the stock price skyrockets.

But what are those mysterious numbers called the Dow Jones Industrial Average, the S&P 500 and the NASDAQ Composite Index that are always reported on the evening news? These aren’t individual stock prices, but broad market averages designed to give you a general idea of how companies traded on the stock market are doing.
What these averages tell you is the general health of stock prices as a whole.

As an investor, you have several options for buying or selling stock. There are dozens of companies that are authorized to trade with the major U.S. stock exchanges and even foreign exchanges like the Tokyo or London Stock Exchanges. If you call an investment house like Merrill Lynch, Charles Schwab or Morgan Stanley, they’ll connect you to a stockbroker who can make your trades for a fee.