How Do Stocks Work? [All the Info You Should Know]

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Have you ever considered the stock market to be the perfect place for you to invest your money and build your wealth?

If you have, you’re on the right track. But how do stocks work?

Read on and find out the essential facts and information regarding stocks, how they work, and how you can invest in them.

We’ll also explain how you can buy or sell stocks, and make a profit from them.

After this article, you’ll be all set to enter the investment game and make the most of it. Read on to see our simple explanations that will have you ready to invest in no time!

What Are Stocks?

Stocks, also known as shares, are ownership equity of a company.

By investing in stocks, you are buying a portion of an organization. That means you can obtain a right to a vote on certain meters of the company, as well as a portion of its revenue in the form of capital gains or dividends.

Depending on how many stocks, or shares of a company, you purchase, you own an equivalent portion of the company compared to the number of its outstanding shares.

For example, if a company has one million outstanding shares, and you buy 10,000 of them, that would make you the owner of 1% of the company.

DID YOU KNOW? The number of outstanding shares of many companies is counted in millions, or even billions!

How Do Stocks Work?

Companies that want to raise money to achieve a certain goal, or to expand their business, may decide to issue stocks. They usually do it through Initial Public Offering (IPO).

By doing so, the status of the company changes. From a private company with a few shareholders, it becomes a publicly traded company whose shares can be owned by numerous investors and members of the general public.

Once the shares of a company are listed on the stock exchange, you can buy them through a certified stockbroker.

After mastering how to invest in the stock market, you can make a profit by selling stocks at a higher price when the value of the company goes up. Some stocks also pay dividends, a portion of a company’s profits, usually quarterly.

DID YOU KNOW? The largest IPO was in 2014 when Alibaba Group Holding Limited offered its shares for a total of $ 21.77 billion. This IPO is still the record as of May 2021.

Types of Stocks

Not all stocks are the same. Wondering how do different types of shares work? We’ll explain the main types of stock below.

Common Shares

These shares are used synonymously with the term “equities”. Their trading volume, as well as market value, are substantially higher than with other types of stock.

When people are talking about stocks, they’re usually referring to common stocks.

The main characteristic of common shares is that they usually imply voting rights. This means if you buy a common share of a company, you will most likely have a saying in important matters, like the election of the members of the board.

To master stocks 101, you must know that not all common stocks necessarily come with equal rights. Sometimes, to obtain the possibility of the owners controlling their wealth, some companies have several classes of common shares.

In that case, every class has a different number of votes per share.

Preferred Shares

Unlike common shares, preferred stocks usually don’t come with the right to a vote. Instead, they have preferences when it comes to dividends and assets in case of liquidation.

This type of share has lower potential when it comes to long-term growth.

However, in the stock market summary, preferred stocks are considered a safer option if you’re looking for income due to usually higher, guaranteed, and fixed dividends.

Dividend Producing Stocks

If you’re on the lookout for regular income from your investment, stocks that pay dividends might be just the thing for you.

Dividend stocks pay their holders a portion of the company’s profits, usually every quarter.

These stocks mainly come from well-established companies, and the best of them may even increase their payments over time!

You can invest in dividend-bearing stocks by purchasing a mutual fund or an individual stock.

DID YOU KNOW? Stocks are further divided based on several criteria, such as the size of the company, industry, location, and future predictions of companies’ growth.

How Does Buying and Selling Stock Work?

You can buy or sell stock on the stock exchange with the help of a stockbroker. Different stock exchanges operate within various market hours.

Buying and selling stocks, in the long run, can have significant benefits for your budget, even if you’re just investing in a few.

They can also provide you with a certain level of security for when you decide to retire and enjoy things you never had time for. If you want to make smart choices while planning ahead, check out some of the best retirement funds.

But how does investing in stocks work?

To kick start your investment and access the stock market, you will need an investment account. Other than that, we’ve gathered the most important facts that will help you understand the stock market.

What Is a Stock Market?

Public trading companies that have issued stocks don’t buy and sell them directly. Instead, stocks are sold and bought among shareholders.

The stock market is the place where investors come together to buy or sell stocks. In the past, stock markets were placed in public venues, but nowadays they are mostly electronic marketplaces.

The stock market works through a well-spread network of stock exchanges. Although these terms are often used interchangeably, they are not quite the same.

A stock exchange is a part of the stock market.

To answer the question of how does the stock market work, you need to be aware that, besides stocks or equities, other forms of financial securities like commodities, currencies, bonds, etc. are also traded on the stock market.

What Are the Most Popular Stock Markets?

The most popular stock markets, or stock exchanges, have thousands of listed companies, forming some of the largest exchange markets in the world.

The largest stock exchange is the New York Stock Exchange (NYSE) with an equity market capitalization of over $25.6 trillion as of February 2021.

Other large stock exchanges are:

  • NASDAQ, United States
  • Hong Kong Exchanges
  • Shanghai Stock Exchange, China
  • Japan Exchange Group
  • Euronext, Europe

Stock Index

How do stocks go up? It all starts with a stock index.

A stock index refers to the statistical measure that is used to represent a collective performance of a certain portion of the market in a standardized manner.

We know that’s a lot, so here’s the simple version:

Before you invest, you should know how to evaluate a stock; the stock index is a very valuable source of information for this.

Stock indexes help investors calculate market performance by comparing current price levels with previous ones.

Using this data, you can choose and invest in index funds, which are the funds created to mimic a certain stock index and match their performance.

When deciding to invest in an index fund, you should research different stocks, each background, and their chances in the index value over time.

The important thing to keep in mind when interpreting stock indexes is to focus more on percentages, rather than point movements.

Here’s why:

If the value of a certain index goes up for 1000 points, and the other by 100, that doesn’t necessarily mean that the first one is performing better. It depends on the points they had before that, so pay close attention to the percentages.

Now, you may be asking yourself: how do stocks work when it comes to index funds?

The higher the percentage gain, the more profit you make investing in an index fund that tracks the particular index.

The most well-known and used stock index is the S&P 500. This shouldn’t come as a surprise since it includes about 80% of all stock trades in the U.S.

Different stock indexes track a specific portion of the market. For example, if you’re interested in tech companies, the NASDAQ stock index closely monitors the technology sector.

Stockbrokers and Online Brokers

To be able to trade on the stock exchange, you need to either be a member of the exchange or be a part of a member firm.

Even though one way of buying stocks is purchasing them directly from a company, it’s far easier to use the services of a stockbroker. Also known as investment advisers or registered representatives, stockbrokers are the middlemen between investors. They buy and sell stocks on your behalf, and make moves according to your instructions.

To keep things simple, check out some of the best stock brokers for beginners.

Other than full-service brokers who give personalized advice and help manage finances in exchange for a significant fee, you can use discount brokers. They don’t provide financial advice, but still, allow you to make transactions with a small or nonexistent fee.

In the early days, trading on the stock market was a privilege of wealthy people with substantial amounts to invest. The development of the internet and new technologies, however, have made the possibility of stock exchanges more accessible and achievable.

So, how does selling stock work today?

Most stockbrokers nowadays are online stockbrokers with simple and easy-to-use platforms.

Technology is even a step further; you have the option of using Robo advisors based on complex algorithms available through a web or mobile app.

To fully understand what the advantages of this option are, find out more about how Robo advisors work.

Market Makers

Market makers are market participants that buy and sell stocks (or other forms of financial securities) to help keep the liquidity of the stock market.

Market makers are often brokerage companies and investment banks. What market makers essentially do is buy and sell shares at any given moment. Let’s say you decide to sell a certain number of shares you own. It’s highly unlikely that you will find the buyer at that very moment.

But then, how does the stock market work?

This is where market makers come in: they will buy your shares and have them ready for sale when a buyer appears. The same goes the other way around. Without them, trading would go slower, resulting in a more complicated and risky process.

Market makers buy stocks for the bid price or the price they are willing to pay for the stocks. After that, they then sell them by the asking price or the minimum price they are asking for the stocks.

They make a profit on the bid-ask spread, which is the difference between the price they bought the shares at and the price they will sell them for.

Although the spread is usually very low by share, there are between thousands and millions of shares traded in this way daily.

What Are Stock Prices?

Every stock comes with a price that is set by financial experts when the company issues them.

The price should reflect the general value of the company: it depends on how much profit it’s expected to make, how successful its products or services are, how many stocks are issued, and so on.

After that, many different factors may influence the price. These can include local or global events, but also ones taking place in the company itself.

One of the major factors dictating the price on the stock market is the law of supply and demand.

This simple principle states that if there is a high demand for certain stocks, but the supply is low, their price will go up. On the other hand, if the demand is low, but the supply is more than enough, the stock will fall in value.

Share vs Stock

These terms are often used interchangeably, but are they the same?

When people say stocks, they usually refer to equities of ownership in one or more different companies. Shares, on the other hand, is a term often used for the ownership of a single company.

Technically speaking, a share is the smallest part of the company’s stock.

The difference between these terms is not so much legal or financial, at least in American English.

Key Takeaways

Stocks represent a portion of the company’s ownership.
You can buy and sell stocks on the stock exchange using the services of a stockbroker.
The two well-known types of shares are common and preferred shares.
The stock market mainly works on the principle of supply and demand.
You can earn a return from stocks by selling them at a higher price or receiving a portion of the company’s profits through dividend-bearing stocks.

Why Do Corporations Sell Stock?

When companies need to raise money, they often decide to issue stocks. The most common reasons being to:

  • Expand their business
  • Develop a new product
  • Pay off debt

DID YOU KNOW? Some of the biggest companies today, Facebook and Apple included, started as small private firms in a student dorm or a garage. With the idea raising and the need for additional capital, they issued stocks and used the money to expand and go global.

Why Do People Buy Stocks and Why Do They Sell Them?

If you want to make a profit and build a high net worth, it might be better to choose to invest in successful companies instead of spending money on liabilities that don’t generate income.

When investing in stocks, there are a few ways to upscale your investment:

The Stock Appreciates

This means that it goes up in value. If this happens, you can sell your stocks at a higher price than you paid for them and earn a return on your investment.

Stocks May Pay Dividends

This is an important stock benefit. Successful companies may pay significant dividends depending on how many stocks you own and what kind.

Protect Your Money

By investing in stocks, you will most likely have better tax treatment in the long run, and taxes and inflation will not influence your wealth.

There are several reasons you may sell your stock, such as thinking that their value will go down or simply not wanting to own a portion anymore.

Of course, when a stock appreciates, it can also be a good time to sell!

DID YOU KNOW? You can use your dividends to reinvest them. You can do this by yourself, but most companies offer a Dividend Reinvestment Plan (DRP) and automatically reinvest your dividends, buying more shares on your behalf to simplify the process

Conclusion

Now that you know how to invest in the stock, you can find the best cheap stocks to buy or continue learning about more specific trades, like how to invest in cryptocurrency.

Whatever you decide, bear in mind that although the stock market carries a certain amount of risk, it can also bring you great benefits.

To remain on the safe side, make sure you adapt your investment to your financial possibilities and use some of the best investment tools available.

FAQ

What happens to stock when a company is bought?

If a company you own a share of is bought, you will usually end up with the money for your shares deposited into your account after the acquisition process.

If the purchase wasn’t in cash but instead in the other companies’ stock, you will receive the share of those stocks that now belong to you.

What is a share of stock?

A share of stocks is the smallest unit of ownership in a company. However, it’s not the smallest part of the company that an individual shareholder can own.

Many brokerage companies allow their clients to purchase a portion of a share of stock. This is particularly useful with successful companies whose stocks are of high value.

What are shares in the stock market?

Shares or stocks are financial instruments that represent a portion of a company traded on the stock market.

How do stocks work? The simple explanation: when you purchase a stock, you own a part of the company. Depending on the type of share, you can have a right to a vote as well as a portion of the company’s profits.

ABOUT AUTHOR

I learned a lot about finance after working for a digital marketing company specializing in investing and trading stocks, forex, etc. After that, I got exposed to other verticals such as wealth management and personal finance, which further improved my understanding of the financial world.

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