You’ve reached the point in your life when you’ve got a bit of money to spare and you’ve been told the stock market is the place to put that money to work. Perhaps the most important thing you need to understand about stocks is that they are bought and sold in markets, not stores.

Walk into a retail store and you’ll pay fixed and non-negotiable prices. If you’ve ever visited one of Europe’s great public markets where goods are bought and sold, you already know more about the stock market than you realize. In a true market, the price you pay is not pre-determined—it is subject to the basic economic laws of supply and demand.

The simplest way to understand supply and demand is to visualize a vendor booth in a public market surrounded by a mob of customers with the people in the back jumping up and down and waving their arms in the air. What does that tell you?

Whatever that vendor is selling, the number of people clamoring to buy tells you that the product is clearly in high demand. It also tells you the supply must be limited. If there were many vendors in the market selling the same product, there wouldn’t be a crowd around the booth. Finally, it tells you that when a buyer “bids” or names the price that he or she is willing to pay, the seller can “ask” for a higher price. If there are only one or two people around the booth, the seller is more likely to lower his “ask” price and accept a lower “bid.”

In a true market, the price you pay is not pre-determined, it is subject to the basic economic laws of supply and demand. When buyers outnumber sellers, the price rises. When sellers outnumber buyers, the price falls.

Now that you have a basic idea of how the price you pay for a stock is determined, we need to look at just exactly what is it that you’re buying.

What are Stocks and Shares?

At a cocktail party, friends proudly tell you they are investing in the stock market. They own shares of British Petroleum and HSBC bank. Is there any difference between a stock and a share?

While the two are used interchangeably these days, there is a slight technical difference. Stocks traditionally refer to the general investment category. Other investment categories are certificates of deposits, bonds, and government treasury notes. A share refers to ownership of a specific company.

So when you buy a share in BP, you’re essentially buying a piece of the company. You become a partial owner of BP, along with millions of other partial owners, or shareholders. With ownership comes the right to vote on company business proposals and the right to share in company profits. There are different levels of ownership, called common and preferred, which convey different rights. Common stock is less expensive and represents a much larger percentage of shareholders than preferred stock does.

When you buy a share, you’re essentially buying a piece of the company. You become a part-owner, along with other partial owners, or shareholders.

Now that you have a basic understanding of what you’re buying, let’s explore why one would choose stocks over bonds or certificates of deposit or treasury notes.

Why Should You Invest in the Stock Market?

In 1994, Jeremy Siegel, a finance professor at the prestigious Wharton School of Business in the U.S., published the results of his study of stock market performance compared to the performances of other investment categories over a 200-year period. The book is entitled Stocks for the Long Run, and it has been called one of the top-ten investing books of all time. His conclusion was this: over time, stocks outperform other investment classes, including property. This is not to imply that the stock market will make you rich, as there are risks involved and history does not always repeat itself.

However, if you take the time to learn more about general market performance and the performance of specific stocks and groups, or “sectors” of stocks in similar businesses, the chances are that you will get a positive return on your investment over time.

People invest in the stock market to make money. Money is made in the market in three ways—a rising share price, a falling share price, and dividends or a share of company profits.

If you buy the shares at £5 per share and sell them later at £7 per share, you’ve made a profit. Obviously, there is always the risk that the share price will drop. However, in stock market investing there is a strategy called short selling that allows you to make money if the share price of a company is falling. Due to the high risk, this strategy is for experienced investors. If your research suggests that a particular company may be in trouble, you can choose to “short” that company’s stock instead of buying the stock. You short a company by first “borrowing” shares at the £5-per-share price. If the price drops to £3 or lower you buy the shares at that price and keep the difference as profit.

You can also make money in stocks through the income in dividend payments that some companies offer their shareholders. Financially successful companies have the enviable problem of deciding what to do with hefty profits. In the early stages, many companies choose to invest profits into growing their businesses. More mature companies often choose to pay out a portion of the profits to their shareholders in dividend payments.

If the company has preferred shareholders, they receive pre-determined dividend payments before dividend payments are made to common shareholders. Dividends for common shareholders are at the discretion of company management. Companies that have paid out dividends in the past can elect to pay smaller amounts or even eliminate dividends in an upcoming period. On the declaration date, management announces the amount of the dividend and the record date it will use to determine eligibility of shareholders for the dividend. Investors who own the stock as of the record date will receive the dividend. However, because of the processing time involved in recording a stock purchase, investors need to know the ex-dividend date, which is generally two days prior to the record date, allowing enough time for a stock transaction to be completed.

People invest in the stock market to make money. Money is made in the stock market in three ways—a rising share price, a falling share price, and, in some, cases dividend payments

How do you make this process happen? What are the mechanics of buying and selling stocks?

Buying and Selling Stocks

In the very distant past, some entrepreneurial business owner came up with a plan to raise the money he needed to grow his business. The owner had a way to dramatically increase profitability, if only the necessary capital could be found. So the owner went off in search of friends and offered them stakes in the business in exchange for a sum of money. While the process worked, it was hardly efficient. Owners didn’t always have the time it takes to make the contacts, therefore, middlemen—brokers—entered the process. Almost all of today’s buying and selling of stocks goes through stockbrokers. A few companies allow people to buy directly from the company through share purchase plans. However, unlike those public markets discussed earlier, most individuals need an intermediary to buy stocks.

Another difference is where the stocks are actually bought and sold. The majority of transactions today take place without a physical market. Individual stocks are listed on stock exchanges. Exchanges have conditions that must be met for listing. Smaller companies that cannot meet the conditions typically trade “over the counter,” or OTC.

The Internet makes it possible for individuals to place a trade directly without calling or visiting a broker. However, Internet access platforms are only available through brokerage houses. Some of these offer full service, which includes financial advice regarding what to buy and when to sell, as well as entering your purchase or sale, for a fee of course. There are discount brokers with very low fees who offer no advice and simply provide a method for you to buy and sell through the appropriate stock exchange.

Discount brokers and Internet trading platforms have made it easy for the average person to invest in the stock market. However, despite the easy access and the historic track record of stock returns, many people avoid the stock market like the plague. One of the major reasons is the lack of certainty. With fixed investments, you know what you’ll pay and you know what you’ll get in return. Making money in the stock market is subject to the rise and fall of the price of the shares you buy. Navigating that minefield is what separates those who succeed in the stock market from those who fall short.

Stocks are listed on exchanges and bought and sold through stockbrokers—either higher-priced full-service brokers who offer advice, or discount brokers who simply provide a means to buy and sell.

Stock Price Fluctuations

The pat answer to the question of why stock prices go up and down is supply and demand. But what factors influence supply and demand? Why were so many people crowded around the vendor booth in the public market? Was there something unique about the product? What happens if someone comes along with a similar product at a lower price? What happens when people have less money to spend?

There are not always easy answers to the question of what influences supply and demand; that’s what makes stock market investing so challenging and at the same time so rewarding. Ask a friend or colleague who has been in the market some time about what it feels like to spend time reading and researching and uncover a stock that rises far above the price they paid.

The forces of supply and demand that drive the prices of stocks are not always easily understood. Competitive products and general weakening of economic conditions are a few examples of factors that can have an effect on stock prices

Bottom Line

The stock market is a virtual market place where buyers and sellers exchange shares of individual companies in order to make money. Investors get a return on the money they put into the stock market through 1) selling their shares for prices that are higher than the prices that they paid for the shares, and 2) dividend payments they receive while they own the shares.

Shares are bought and sold through brokers. Some brokers offer advice as well as the management of your purchase or sale, and others simply offer a means of placing your buy and sell orders, either through the Internet or by phone.

Summary:

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In a true market, the price you pay is not pre-determined, it is subject to the basic economic laws of supply and demand. When buyers outnumber sellers, the price rises. When sellers outnumber buyers, the price falls.

 

P

When you buy a share, you’re essentially buying a piece of the company. You become a part-owner, along with other partial owners, or shareholders.

 

P

People invest in the stock market to make money. Money is made in the stock market in three ways—a rising share price, a falling share price, and, in some, cases dividend payments.

 

P

Stocks are listed on exchanges and bought and sold through stockbrokers—either higher-priced full-service brokers who offer advice, or discount brokers who simply provide a means to buy and sell.

 

P
P

The forces of supply and demand that drive the prices of stocks are not always easily understood. Competitive products and general weakening of economic conditions are a few examples of factors that can have an effect on stock prices.

  

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Comments

benjakk
# benjakk
Sunday, June 8, 2014 1:37 PM
Thank you thank you thank you tradingfo for providing this info for everyone
RachelDenton
# RachelDenton
Saturday, July 26, 2014 9:25 AM
Great article on stock info one who don't know what really a stock is can easily learn through your article.
Community Support
# Community Support
Saturday, July 26, 2014 1:24 PM
Hi Benjakk, RachelDenton,

Thank you for your positive comments. Your feedback is always welcome :)

If you like this article stay tuned for more weekly articles. Also, you might find interesting our stock fundamental analysis. You can find this in the learn section under "Fundamental analysis".

Fire away with any questions you might have.

Happy trading,

Gino

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