How to Understand the Stock Market?

The Stock Market has a very strange place in the minds of most people around the world. Many of us hear about it on a daily basis, but we still don’t really understand what it’s all about. It’s constantly featured in mainstream movies, news segments, and books, and yet, most of the terminology still sounds like gibberish. But why is this? Well, perhaps the biggest challenge lies in its depth and scope. There are so many words and phrases specific to the stock market, that newcomers are often scared off before they can get a feel for things. If we want to get past this barrier, maybe the best move is to go through the basics nice and slow and ask ourselves a couple of important questions, like – What is the stock market? How does it work? And how can I get involved? How to Understand the Stock Market?

The stock market is an umbrella term that refers to the various markets or exchanges in which stock is bought and sold in the form of shares. 

Ok, that wasn’t as simple as it could’ve been so let’s go through each term and break it down further – 

  • Stock – Stock represents a portion of ownership in a company (although this doesn’t mean that you actually gain control of the company). Companies sell stock to generate capital and other groups and individuals can then purchase this stock as a type of investment.
  • Shares – These are the units of measurement that makeup stock. Simply put, a person with 100 shares of a company and a person with 10 000 shares both own stock in that company, just in different amounts. In other words, shares refer to a specific amount while stock does not. 
  • Stock Exchange vs Stock Market – While these terms are often confused, they actually have a notable difference. Stock exchanges are normally specific areas or markets where trade occurs, whereas ‘the stock market’ technically refers to all of these exchanges together. In other words, you buy shares via a specific stock exchange which means that you are participating in the stock market, generally. 
How to Understand the Stock Market?
How to Understand the Stock Market?

Ok, so now that we know the basics, let’s run through that definition again in detail. 

The Stock Market is a collective term that refers to all of the various stock exchanges (usually within a specific country) where companies sell their stock in the form of shares to raise funds. These shares are then bought and sold by other groups, normally in order to make a profit. Stock markets are normally used as indicators of the health of the economy more broadly. 

Beginner’s Tips

So what happens if you want to start trading stock? Can anyone do it? And what do you have to keep in mind?

  1. Open a Brokerage Account – To begin buying and selling stocks, you’ll need a special account known as a brokerage or trading account. There are many outlets which provide this service online as well as various banks.  
  2. Do your Homework – You’ll need time to familiarise yourself with the ins and outs of the stock exchange before you put any real money on the line. You may even practice ‘fantasy investing’ via simulations. Imagine actually investing money in a certain kind of stock and then track its process to see how well your hypothetical decision would’ve turned out. 
  3. Determine your Budget – Trading stock can be a costly mistake if you make enough bad calls. Try to ensure that you understand your financial situation and work out how much you can afford to invest accordingly.  
  4. Pick your Stocks – Once you’ve got a handle on the technical side of things, you can pick your stock and begin trading. It’s always a good idea to diversify your investments as this may provide a certain level of risk mitigation if done correctly.  
How to Understand the Stock Market?

What are the 4 Types of Stocks?

Given the inherent size and complexity of the stock market, it should come as no surprise that there are many different kinds of stock for you to choose from. That said, certain types are more common than others and will often form the basis of the average portfolio, they include, but are not limited to – 

Types of Stock

Common Stock – Common stock (as the name suggests) is more readily available than its counterpart known as ‘preferred stock’. Common stock usually allows the holder to vote on certain corporate decisions such as mergers. Common stock tends to be a riskier investment but can also experience extreme increases in terms of its value. 
Preferred Stock – Once again, the name says it all. Holders of preferred stock are usually prioritized when it comes to the payment of dividends and/or payment upon liquidation, they are generally seen as a safer investment overall. One downside, however, is that they normally do not include the voting rights that are available to holders of common stock. 
Growth Stock – Instead of paying out good dividends, this stock tends to favour an above-average rate of growth and can provide better returns in the long run. The downside is that they are usually a riskier option than Income Stocks.
Income Stock – These shares operate in contrast to a growth stock. Instead of prioritizing high growth, income stock promises better dividend payouts to shareholders. 

How do you Make Money from Stocks?

Ownership of stock provides money in two key ways, firstly, shares can operate exactly like any other type of investment and increase in value over time, you can then sell them for a much higher price than you bought them for.

Alternatively, certain types of stock can pay dividends on a fairly regular basis. Instead of selling your profitable stock you can simply keep it where it is and receive frequent payouts as an extra source of income. 

Does Owning Shares make you an Owner?

While owning shares in a corporation does grant you some portion of ownership overall (specifically in terms of its assets and earnings), you do not actually own or gain control of the corporation itself. 

Although majority shareholders do hold an incredible amount of influence over various functions in the form of voting power, thanks to the separation of ownership and control, they cannot simply take over the business. In other words, even if you own shares in a company, you cannot just move into the office building and set up shop. 

How to Understand the Stock Market?
How to Understand the Stock Market?

Do Stocks Pay you Monthly?

Not always. Each company determines its own payout schedules, so while some stocks do pay monthly dividends, others may do so on a quarterly or yearly basis. 

There are many other caveats that also have to be considered when it comes to such payments, for instance, some businesses may not pay dividends unless they turn a profit over a certain period of time, while others will still pay even when their profits slump in an attempt to maintain a good payment track record.

Additionally, some types of stock pay very little in terms of dividends (if any at all) and instead focus on reinvesting the profits they make back into the business. 

Who gets your Money when you Buy Stocks?

The money gained from stock sales usually goes to the corporation that initiates the sale. Corporations sell stock in an attempt to raise capital for their business.

In Conclusion – What is the Stock Market and How Does it Work?

The Stock Market is a collective term that refers to the various stock exchanges that operate throughout a country or throughout the world. A stock exchange is simply a market in which individuals and organizations can come together to buy and sell shares, which are the units that makeup stock.

The stock market is commonly used as a means to measure the economic health of a nation. 

Shares are like any other investment, they are bought in the hopes that they will increase in value over time. Once your shares grow you can either sell them for a profit, or you can begin to receive dividends paid by the corporation at certain intervals. 

The frequency of such payments is normally decided by the board of directors and certain shareholders may be prioritized for payment over others. Additionally, some companies pay very little in dividends and instead reinvest their profits in order to further grow the business.

How to Understand the Stock Market?
How to Understand the Stock Market?

By becoming a shareholder, you are purchasing a type of ownership over the company, although this manifests primarily in a share of their profits rather than indirect control over the business itself. That said, certain types of stock do not provide the same voting rights as others. 

The payment of dividends is a highly contextual affair and is usually determined by the corporation’s board of directors. They may choose to pay dividends regularly or irregularly or may even decide to cancel payments and use the profits to further growth. While most shareholders will have some voting rights when it comes to the appointment of the board of directors, it is the majority shareholder who will have the lion’s share of the influence. 

Disclaimer Finance101: All of our posts are for research purposes only. Finance 101 aims to assist its readers with useful information on the laws of our country that can guide you to make financial decisions that will enable you to become more financially independent in the future. Although our posts cite the constitution in many instances, they are intended to assist readers who are looking to expand their knowledge of the law & finance-related queries. Should you require specific legal/financial advice we advise you to get in touch with a qualified financial expert.

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2 Responses

  1. February 28, 2022

    […] in dividend-paying stocks, you can reinvest your earnings and buy more shares. In this sense, dividend-paying stocks can operate (at least in principle) as compounding […]

  2. May 16, 2022

    […] in dividend-paying stocks, you can reinvest your earnings and buy more shares. In this sense, dividend-paying stocks can operate (at least in principle) as compounding […]

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