If you’re new to investing, you may be wondering how stocks work. In some time periods, the stock market may potentially offer better returns than a CD or savings account, but what happens when you invest in the stock market? What are you actually investing in?
Maybe you’re looking to invest for retirement, or maybe you have extra cash that you’re looking to put to use. Understanding how stocks and the stock market work can help you make smart investments and avoid common pitfalls.
- Stocks are a kind of financial instruments that gives the owner a fractional share of the issuing company.
- Stocks are traded on an exchange, and the value of these stocks can fluctuate over time.
- Knowing how to make sound investment decisions can take the stress out of investing so you can focus on your long-term goals.
Table of Contents:
- What Are Stocks?
- What is the Stock Market?
- How Does the Stock Market Work?
- How are Stock Prices Set?
- How Does Trading Work?
- Minimizing the Risks of Investing in Stocks
- Why Invest in Stocks?
- Frequently asked questions
What Are Stocks?
A stock (also known as equity) is a type of financial instrument that represents fractional ownership of the company that issued the stock. Each unit of stock is called a share, and each share grants the shareholder ownership of a part of the company.. Investors with more shares may potentially earn more from the company and may be able to have greater control over some decisions made at the company.
To understand stocks, think of a business run by five partners. Each partner work together and has an equal ownership, ⅕ of the company In other words, each person has one share (out of five possible shares) in the company. That share confers the right to a proportional amount of the profits, if the company decides to distribute profits vs reinvest, and voting power.
When corporations go public, they issue stock on an exchange. When investors buy this stock, they contribute funds to the company that helps them grow. In return, some of those investors now have the right to vote in shareholder meetings, receive announced dividends, and sell the stock to other investors.
Types of Stocks
There are a variety of stocks available to shareholders, but most investors will buy one of two types of stock: common stocks and preferred stocks.
- Common Stocks — As the name suggests, common stocks are the most popular type of stock individual investors buy. Owning a common stock allows investors to have voting rights, and earn dividends. Common stocks also have the potential for higher long-term returns, but are also more volatile.
- Preferred stocks — These types of stock give preferred stockholders different treatment when paying dividends (distribution of profits). They are paid before common stockholders and generally earn higher dividends that are fixed. The returns are often lower, even over the long term, and are less volatile in day-to-day dips and spikes. Preferred stock owners do not have voting rights.
Stocks can be classified into many different types, such as small-cap, mid-cap, and large-cap stocks, international and domestic stocks, and growth and value stocks.
What is the Stock Market?
The stock market consists of exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ, where stocks are listed. Buyers and sellers come to the stock market to buy and sell shares of stock in companies, which is facilitated by a brokerage firm.
When an investor buys stock, they are hoping that the stock will go up in value. The ultimate goal of an investor is to sell the stock for a profit.
How Does the Stock Market Work?
The stock market fluctuates and is based on supply and demand. If more investors are buying the stock than selling it, the demand for that stock goes up and the value tends to increase. This often results when investors believe the value of the company’s stock will increase as a result of strong financial performance or other market factors. Conversely, when investors believe a stock will perform poorly, they’ll sell it, which floods the market with supply and decreases demand. This lowers the price of the stock. Public Trends shows stock performance over time, helping investors understand long-term movements in stock prices.
In addition to purchasing individual stocks, some investors choose to buy shares in an index fund. These index funds buy a selection of stocks or other assets. To purchase stock, investors need a brokerage account, like those offered by Public. Investors who want more guidance on their investments may opt for Public Premium, which offers company-specific insights from leading analysts that can help investors decide which stocks may be appropriate for them
Stock Exchanges, Stock Indexes, and the Stock Market
When it comes to investing, the most challenging part is learning the basics of the stock market and understanding the different terms used by investors. Here are a few key terms you’ll see used by investment professionals:
- Stock Exchange — An exchange is the middleman that connects buyers and sellers who want to trade stocks, bonds and other securities. A well-known example is the New York Stock Exchange (NYSE).
- Stock Market — The stock market refers to a collection of exchanges where companies list shares of stock for sale. Investors can then buy and sell these stocks among each other.
- Stock Index — An index gathers data from a variety of industries and helps investors calculate performance. Some indexes even look at specific industries. The three most popular indexes in the US are the Dow Jones Industrial Average, Nasdaq Composite, and the S&P 500.
Still unsure about what investing terms mean? Using Public’s social investing feature, you can reach out to fellow investors who can help you understand how to invest in certain stocks or industries.
How are Stock Prices Set?
When a company decides to go public, there will be an initial public offering (IPO) where investors can purchase shares in the company. The company will work with investment bankers to set a primary market price. That initial price is determined by the valuation of the company and perceived demand in the market. These shares will then be offered to preferred institutional and individual buyers.
Companies choose to IPO on a certain exchange, like the New York Stock Exchange (NYSE) or NASDAQ. After the initial offering, the stock becomes available to all individual investors trading on that exchange. At this point, the share price will start to fluctuate based on what buyers are willing to pay and what sellers are willing to accept.
Supply and demand can have a big impact on the stock market. As a company becomes more valuable over time, stock prices can rise, making those stocks valuable to their stockholders.
How Does Trading Work?
Anyone can trade shares of stock. Signing up with Public is fast and easy:
- Open a brokerage account. Public is a fully regulated broker-dealer, which means that securities in your account are protected up to $500,000.
- Decide what stocks you’d like to invest in depending on your interests and budget. Public’s social investing tools let you communicate with other investors, while the Top Movers tool can help you identify stocks that are rapidly increasing or decreasing in value.
- Find the stocks you want to buy on Public and specify the number of shares. At this point, you can also set a limit order, which is the maximum price you’re willing to pay for the stock.
- Public will relay your order through a stock exchange and will buy or sell your shares at the going price for that stock.
- After the sale has been finalized, the transaction will be available in your Public account.
Investing in the stock market can be exciting, and Public’s suite of social tools and professional guidance can help you learn how to navigate the market and decide on an investment strategy. Here are a few things to keep in mind as you start to invest.
- Keep your emotions in check. Volatility in the stock market should be expected. When you become emotional about investing, you can make poor decisions and derail your goals.
- Choose your investments based on facts. Before choosing your stocks, research the background and financial stability of the company. Remember, when you buy stock in a company, you become part-owner, so consider the stock’s price target. Public Premium users get access to insights from Morningstar, which can help investors make smarter decisions.
- Take it slow. Investing in the stock market involves a long time horizon. Start out slow and keep in mind that your strategy should ensure that you can ride out market fluctuations.
- Diversification is key. The most important thing you can learn about investing is to diversify your assets. Owning stocks in a variety of markets and adding other types of investments can give you a well-balanced portfolio that doesn’t rely on one company’s success, allowing you to recover from a loss more easily.
Minimizing the Risks of Investing in Stocks
The stock market tends to fluctuate, which is why most financial advisors suggest that investors diversify their portfolios. Different asset classes come with their own risks.
Many new investors choose to invest in exchange-traded funds (ETFs), which are securities that are traded like stocks. Bonds, which are loans from an investor to a company or government that are paid back at a fixed rate, are another popular option. While it is historically more volatile than the stock market, many investors also choose to buy cryptocurrency as a way of diversifying their portfolios.
Why Invest in Stocks?
The simple answer is that owning stocks and maintaining a diversified portfolio can help increase your savings over time to help you reach your financial goals. The three most beneficial elements include:
- Building with a long-term view. Past performance indicates that the stock market will inevitably trend upward. Investing with a long time horizon can help you meet your financial goals.
- Protect your investments inflation. Investing can provide a hedge against inflation, since the market tends to outperform annual inflation rates.
- Increase wealth. Building a nest egg for the future requires more than a savings account. Dividend reinvestments compounding over time can work to exponentially increase your savings in the long term.
Stock Market Basics
Investing has many moving parts. Luckily, Public is here to help. Our community of investors can answer your investing questions, helping you feel more secure as you start out. On Public Live, industry professionals offer commentary on the market and useful information for new investors.
Ready to start investing? Download the Public app to get started.
Frequently asked questions
How do you make money from a stock?
Investors buy stock at a certain price, which is based on the current market conditions. If the price of a stock goes up, investors can sell the stock for a profit. If the price goes down, investors may be selling at a loss.
Can you lose money in stocks?
The stock market is unstable and the price of an individual stock can increase as well as decrease. It is possible to lose money in the stock market
What is the difference between stocks and bonds?
Stocks confer partial ownership of a company and can be bought and sold through exchanges. Bonds are a loan from the investor to a company or government and generate a fixed return over their duration and are less liquid
What is the Dow Jones?
The Dow Jones Industrial Average is one of the three most popular stock market indexes in the US.
When do stocks reach their full potential?
There’s no set moment for when a certain stock will reach its full potential. However, investing in the stock market requires a long time horizon, so it’s best to think of your investments in terms of their long-term value.