The stock market is one of the most crucial aspects of the economic growth of any country, helping the government fuel development projects as a result.
In order to understand the state of an economy, all one must do is study the stock market thoroughly. This offers valuable insight on both personal and corporate levels, allowing investors to make an informed decision on choosing the right investment opportunity.
But knowing how the market works is half the challenge, and without the proper know-how of stock exchanges, new investors may stand to lose money.
So, if you’re wondering how the stock market works and where your money goes after buying a stock, read on ahead. We’ve created a simple overview of the stock market to help you gain a better understanding of it.
How Does The Stock Market Work
A stock is, in essence, a stake in the company of your choice. With company stock, you receive a small portion of the ownership in a company, providing access to a small fraction of the profits. Meaning, if you purchase stock in a highly successful company, you will receive a small fraction of the company’s profits.
When these stocks are traded en masse, the result is essentially a market of stocks, known colloquially as the stock market.
There are two main kinds of stock markets, namely primary and secondary markets. The former involves the sale of stocks to investors, and it also includes stocks from Initial Public Offerings. And the latter is where stocks are bought and sold once they’ve been through the primary market. A large bulk of exchange occurs in the secondary market, which is where the trading volume is the highest.
Other types of markets include capital markets and commodity markets, with subsets like equity and debt markets where stocks and bonds are used as securities.
Owning Stocks: The Basics
1. Stock Value
In the long run, stocks can offer a good return on investment, with an average annual return being around 10%. With inflation in mind, the returns diminish a little, reducing to 8% instead.
After investing in a company, you’ll be looking at the stock market for the trajectory of said company. If the price of the stock increases, you’ll gain a fraction of the company’s profits and vice versa. By selling the stock for a price higher than the initial buying price, you’ll make a profit. Some stocks pay dividends monthly, quarterly, semi-annually or annually to shareholders from the profit the company makes.
But as the saying goes, “it’s wise not to put all of your eggs in one basket.” So, you should build an overall portfolio of stocks from successful companies across the world, as each stock has different overall market volatility and return.
2. Stock Types
There are two kinds of stocks: common stock and preferred stock. Common stocks have a high potential for great returns in the long run, giving investors room for long-term fund growth. As an investor, you’ll be purchasing common stock that gives you access to voting rights and shareholder dividends.
On the other hand, preferred stocks are much like bonds that pay investors a fixed dividend and are less likely to lose value over time. This comes with a caveat of not gaining high value either in comparison to common stock. Preferred stocks are generally good for investors who prefer long-term income.
Where Does The Money Go When You Purchase Stocks
So, where does the money go once you buy stocks? To answer concisely, your money goes to the seller through a broker.
When an investor purchases a stock, they likely do it through an IPO (Initial Public Offering) that makes said stock available on the market. This is when they enter the secondary market, where many stocks are bought and sold on a stock exchange.
So, when you buy stock on the secondary market, your money will be transferred to the stock seller instantly. A similar process occurs when you sell stocks, with the value of said stock being converted to money that comes through an intermediary.
What Happens To The Money In Case Of A Price Drop
Money destruction, i.e. it vanishing into thin air, is a fairly rare occurrence in the stock market. If you’re selling stocks at a loss, the money you lose is someone else’s profit. Usually, the one who profited from the deal was the person who sold you the stock.
Now, this is an oversimplification of the stock market, but the gist of it remains the same. Many investors trade stocks with the assumption that the other party will pay more for them in the future. And since stocks can be owned forever, the assumption is generally a sound one.
Price Fluctuations In The Stock Market
Stocks can net you high returns, although they can also cause you to hemorrhage money. It always pays to be cautious when investing in the stock market to receive the returns that you wish.
Stock market indices are a good way to learn how the stock market is performing. You can look at the performance of listed companies to try and predict the market trajectory and the status of the economy.
On that note, some of the common reasons for the fluctuation in stock price include:
Public perception of a company matters heavily when it comes to its stock price. When an investor purchases or sells a stock, they check for the latest news on the specific company or industry that directly impacts the price. More importantly, this information can impact their decision to buy or sell shares.
So, if a company chooses to expand in uncharted territories, the decision may pique the interest of some investors, while others may be wary of it. Depending on the ratio of interested investors to disinterested ones, the stock price may rise or fall.
2. National Economy
The GDP and interest rates of a nation can dramatically impact stock prices and investment bank interest. As the GDP increases, investors will look to raise money for a company. Product-based industries particularly benefit from a nation with high GDP.
But if the interest rates increase, companies will have to pay more money to borrow, reducing profit margins and share values.
3. Financial Status
If a company is bleeding money, investors and shareholders will naturally be averse to the idea of putting more money on the line. Existing shareholders will look to sell their stocks, while new individual investors will not entertain the idea of investing in a sinking ship.
On the flip side, if a company has huge profit margins, it bodes well for everyone involved. Investors and shareholders will be more than willing to buy a stock, and the stock price will continuously rise.
4. External Factors
Sometimes, stock prices are not in the hands of a company at all. Be it external events such as wars or natural disasters, or the general impressions of a company, the stock price will see a drastic shift.
Remember: nothing deters investors from purchasing stocks like uncertainty.
Choosing The Right Stock
1. Study The Market
The market trajectory can point you in the right direction when it comes to choosing the right stock. Certain market-moving events can push the company’s stock price very quickly, affecting the stock trades in price and volume.
2. Choose A Sector
Picking a market sector is not easy if you don’t know much about it. Hence, it’s vital to educate yourself properly before making extensive investments in any given sector.
Study a market sector well before you make a decision, and consult a stock market expert for advice before proceeding.
3. Find Individual Stocks
Once you have the sector that suits you just right, it’s time to find stocks from a particular company. You can opt to look for growth or value stocks, depending on your preference.
Growth stocks are a reflection of the potential success of a company, making them more of a calculated risk. On the other hand, value stocks tend to have a lower price in exchange for relative stability.
4. Look Into The Stock Market History
Each company has investment commentaries available that can help you make an informed decision. These commentaries include the details you need to make an informed decision, including warning signs like product recalls or conduct that negatively impacts the stock price.
You can also look into the revenue, financial statements, and equity ratings of a company. The goal here is to make sure you know enough, but not necessarily everything about the company you invest in.
5. Keep An Eye On The Charts
Recent trends can give you an idea of the stock price trajectory, so keep up with the company stock prices for a while. If the stock price trends upward, it may be safe to invest in the company. And if you find any oddities, you can opt not to buy a stock. After all, the choice of investing rests entirely in your hands.
The stock market is a fickle thing, sometimes giving even seasoned investors troubles when tracking investment opportunities. But it’s always wise to be cautious when picking a stock to purchase.
So, when you do buy a stock, your money remains in the stock market without vanishing into thin air. As the price of a stock rises, you stand to receive more money when you eventually sell it. But if a stock falls, the money remains in the stock market ecosystem, often in possession of someone else.
The most opportune time to buy stock is during a company IPO when common shares are available for all investors in the open market. So, study the market well and seize your opportunity to invest in the company of your choice!
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