Understanding Stock Trading

Just as you have to walk before you run, you have to understand stocks before you understand the stock market and stock investing.

Basically, a stock represents the smallest share of company ownership. This partial ownership, gives the shareholders some rights. These rights include some control in how the company is managed and a share of the profits… if there are any. What's more, while stocks give owners some influence on how the company is run, they do not carry any obligation in case the company defaults, faces a lawsuit or declares bankruptcy. The worst thing that can happen is that the stock becomes worthless.

Why do companies issue stocks?

It's simple: they issue stock to raise capital. Why else would they give up partial ownership of their company? Sometimes they may need some extra cash for expansion or for new properties. Each stock issue is limited to a certain number of shares. At the time they are issued they are given a par value. However, the market quickly changes the stock price according to the perceived growth potential of the company and their financial status.

Why do investors buy stocks?

Generally, investors buy stocks because they believe that the company will continue to grow - and thus the value of the stock will rise too. Buying the stocks of already well-known companies is relatively safe, but investors who acquire stock in a new company are facing a much more substantial risk… but they have much more to gain too.

For instance, those people who bought Microsoft shares in the 80s and kept them for a long time saw an exponential rise in their value - something most investors only dream of.

Where to Trade Stock?

Stock trading is done on stock exchanges. The two best-known exchanges are the New York Stock Exchange (NYSE) and the NASDAQ (National Association of Securities Dealers Automated Quota) Because of that, only companies listed on a public exchange can issue shares that can be bought and sold on the open market.

What if it isn’t listed on an Exchange?

Buying partial ownership in a smaller company can still be done of course, but that will be entirely different kind of investment, one that has nothing to do with stocks. These types of investment are much less liquid and are much riskier. This is called a “Private Placement” while stock on an exchange is called “Publicly Traded”. Theoretically, publicly traded stock provides more protection because the transaction is monitored by the Securities and Exchange Commission (SEC).

Because publicly traded stocks must be traded on a stock exchange, an individual investor always needs a broker who makes transactions for him. Basically, brokers are people who take orders to buy or sell a certain stock in exchange for a small commission on the sale. (In other words they are just glorified sales people).

Stock orders may include instructions to buy or sell stock at a certain price (Limit orders) or simply to trade them for whatever the present price is (market orders). When the order arrives to a broker, he executes it (or rather, tries to execute it) by finding a buyer or seller willing to trade for the ordered price. As you probably see, the other side of transactions is represented by another broker acting on some instructions, too.

Advantages of Stocks

Stocks have several advantages over savings investments. Since each share equals partial ownership in a company, they give the holder some influence over every major decision the company faces. The decisions are made on one share - one vote basis and shareholders are often asked to vote on all important decisions that company is to make. What is more, being a shareholder entitles you to take part in any profits the company makes. They are issued as a dividend once or twice a year, depending on the decision made by company the directors. As the company grows, the value of the stock rises and the profits' distribution along with that. When the company suffers losses you aren't asked to give anything in, but the value of the stocks you have will almost surely fall.

If you compare the stocks with classical savings investments like bonds, bank certificates of deposit etc., you will quickly notice that they have greater potential to earn more money quickly -- but they are much riskier investment, as the chances of loss is real.

However if you know your share about how the stock market works and what the various investment strategies are, you can minimize losses. Most investors find out that they do much better business on the stock market than would be ever possible with any kind of savings investment.

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