Stock Market Investing: How It All Works

Want to learn how to get started with stock market investing? You’re in the right place. In this blog post, I’m going to go over how it all works and how you can get started right now.

What is the stock market?

The stock market is a public market for trading stocks. An efficient active stock market is important for economic growth. It also gives businesses ready access to public capital. The market issues, buy and sell stocks on a stock exchange or over the counter (OTC).

Stocks are also called equities and represent part ownership in a company. The stock market is where, as an investor, you can buy and sell the ownership you have in any such company. As an investor or trader on the stock market, you buy and sell shares of company stock. That’s what stock market investing is all about.

Role of the stock market

The stock market serves the financial sector in important ways. It makes capital available to companies to finance and build their businesses. A company may need funds to expand its business. But may want to avoid taking on debt with its associated costs. Instead, that company can offer shares in its ownership as stocks to the public. The company can then use the funds raised to expand and grow its business.

The stock market also gives ordinary people the opportunity to build wealth. It gives those who buy shares in a company the chance to share in its profits. As an investor, you can benefit in one of two ways. One way is you can earn dividends on each share of stock you own in the company.

The other way you can earn from stocks as an investor is by selling your stocks for a profit. You do so when the price increases. So, you bought shares in a company at $20 a share, and the price goes up to $30. As an investor, you can then get a 50% profit on your investment if you sell those shares.

The start of investment trading

Stock trading dates to the mid-1500s. But the start of today’s stock trading links to shares trading by the East India Company in London. Early investment trading started with European governments. They gave charters to companies that had “East India” in their names.

Goods coming from the east by sea were at risk from pirates and storms. So, ship owners sought investors to finance the trip and share the risks involved. In return, the investors got a part of the profits gained if the ship got back with its goods. The venture was a success. The arrangements were of limited liability and most often were for only one trip.

A new investment model

With the birth of the East India Company in London, a new investment model came into being. Importing companies began offering stocks. They represented a small part of ownership in the company. That gave investors a return on all proceeds from the voyages financed by a company.

With this new model, a company could seek more investments and value per share. This allowed them to increase their shipping fleet size. Investment in these companies was often protected from competition. And so, these investments were likely to gain huge profits. This made them popular with investors.

The London Stock Exchange

Shares for the companies were issued on paper. That allowed investors to trade them with other investors. But trades were not regulated until the London Stock Exchange (LSE) formation in 1773. Much financial turmoil followed the birth of the exchange. But trading survived and grew through the 1800s.

The New York Stock Exchange

The New York Stock Exchange (NYSE) was established in 1792. It quickly became the leading stock exchange in the United States and the world. The NYSE’s physical location among some of the largest banks and companies. Its location as also a major shipping port also makes its position strategic. The standards and fees to list shares on NYSE were high initially. This gave it a chance to grow into a wealthy institution.

Changing stock trading of Global Exchanges

The NYSE had little competition in the local market for over two centuries. This allowed it to grow with the American economy. The LSE dominated the European stock trading market. But the NYSE served a growing number of large companies. Over time other major countries set up their own stock exchanges. But they were often seen mainly as a way to get listing on the LSE or NYSE.

Stock trading gave birth to many other exchanges by the late 20th century. These included NASDAQ the favored home of technology companies. NASDAQ became the first exchange to make trades electronically. The introduction of electronic trading made the trading process more time and cost-efficient.

Apart from the emergence of NASDAQ the NYSE soon faced growing competition. This was from exchanges in other financial centers in the world. Euronext came in 2000 as a merger of the Amsterdam, Brussels, and Paris exchanges. The NYSE merged with Euronext in 2007 to establish the first trans-Atlantic exchange.

Stock trading on Exchanges and OTC

Stock exchanges are marketplaces to allow investors to buy and sell stocks. In the United States, the New York Stock Exchange and NASDAQ are two such exchanges. They are regulated by Government agencies. The Securities and Exchange Commission (SEC) is the agency in the United States. It oversees the market to keep the market in line and protect traders from financial fraud.

Most stock trades are done on exchanges, but some are over the counter (OTC). The stocks that do not meet the minimum price and other requirements of exchanges sell in OTC. In this arrangement, they trade through a dealer. These stocks are not regulated like exchange-listed stocks. So, it is not as easy to get reliable information about the companies issuing them.

Players in the stock market

Regular players in the stock market investing game include investment banks, stockbrokers, and investors. Investment banks deal with the initial public offering (IPO) of a company’s stock. When that company decides to offer shares and become a publicly traded company.

The company engages the investment bank to be the “underwriter” of the company’s offering. The bank researches the company’s total value. Then factors in the percentage of ownership the company is offering as shares. The bank manages the issuance of the shares for a fee and guarantees the company a minimum share price.

IPOs are most often taken up by large investors like mutual funds companies or pension funds. After the stock’s IPO, all its trading will happen through the stock exchanges. There most of the stock trading occurs daily. Stockbrokers buy and sell stocks for clients. Their clients are investors who may be individuals or institutions.

The stock market indexes

Stock indexes are a selection of stocks that show how stocks are performing on the market. The different market indexes track the stock market performance.

Key stock market indexes include the Dow Jones Industrial Average (DJIA). Standard & Poor’s 500 Index (S&P 500) and the Financial Times Stock Exchange 100 Index (FTSE 100). NASDAQ Composite Index, the Nikkei 225 Index, and the Hang Seng Index.

Bull and bear market, and short-selling

The bull market is a stock market in which stock price is rising, generally. This is the type of market in which most investors make money. Most of the stock investors are buyers. There is a bear market when there is a general decline in stock price. But you can still make money in a bear market with short selling.

In short selling as the investor, you borrow stock from a brokerage firm. The brokerage firm does not own the shares and you as the investor will not hold them. You sell the borrowed shares and get the money from the sale. Then, you wait for the stock price to decline. Afterward, you buy back the shares at the lower price to give back to the broker the shares borrowed.

Since you pay less than what you sold for, you make a profit.

Market Cap, EPS, and financial ratios

Stock market investing pros and analysts may look for possible price changes. The changes may be the result of several factors. They include the stock’s market cap, which is the value of all the shares of the stock. A high market cap will show the company is well established and sound financially.

Publicly traded companies must give earning reports quarterly and annually to regulatory bodies. These reports are seen by market analysts as an indicator of the strength of a company’s business. The company’s earnings per share (EPS), is the profit on each of its shares of stock. Several other key financial ratios also show the company’s financial stability, profitability, and growth potential.

Value and growth investing

Most of the methods you can use for choosing stock fall under the two basic buying strategies. Value investing leads you to invest in companies that are well established but may be below market value. They showed steady profits over many years. This type of stock market investing is less risky than growth investing.

With a growth investing strategy you focus on companies with high growth potential. You will take more risk and invest in relatively new companies. Technology stocks are usually the type that attracts growth investors.

I hope this has helped you get started with stock marketing investing and learn about how it all works.

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