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The stock market can be confusing, especially when there is so much misinformation out there. In this post, I write about the basics of the stock market. If you would like a more detailed explanation of mutual funds and investments, refer to my related article, Exposing The Mutual Fund Industry.
If you are still with me, let’s answer the question, “What exactly is the stock market?
If you’re unfamiliar with the stock market, it can look an awful lot like a casino game in Vegas. To make things worse, some people actually play the market as if they are gambling which usually results in devastating losses. Much of the negative sentiment towards the stock market is due to the lack of understanding of it.
My goal for this post is to give you a brief insight into the process and the objective of the market. This is not an exhaustive article – many thick books have been written about the stock market that barely scratch the surface. However, this should give you a basic understanding of the investment vehicle known as the stock market.
What Is A Stock?
A stock is actually a “share of stock” which quite literally is a share or part ownership of a company. When you own a share, you own a small portion of that company which entitles you to a fraction of the assets and earnings of the business.
What are assets and earnings?
Earnings are the income the company makes from the sale of its service or products and the assets are the physical property of the company (commercial buildings, machines etc).
The reason a corporation chooses to sell shares of a company is to bring in additional revenue to invest in further production and income.
The company makes money when it sells shares of stock. Companies use this money when they are small and trying to grow or when they are larger and attempting to expand. The company may later elect to buy its shares back, continue to sell more, or stop selling completely.
What Is The Market?
The market is essentially a marketplace where shares of stock are bought and sold. The market is also commonly referred to as the stock exchange. The three largest markets in the United States are the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) and the National Association of Securities Dealers (NASDAQ).
Each market sells stock from different companies. Certain companies are in the NASDAQ, some are in the NYSE, etc.
The majority of stock trading is done online while a few trades are done on the floor of the physical market. The floor of the physical market is the place you see people running around while on their phones. They constantly are looking up at the televisions that show the current stock prices.
These are brokers making purchases for their clients. However, with the age of the internet, it’s extremely convenient and reliable to make your purchases online as an alternative.
What Makes Stock Prices Go Up Or Down?
Usually company performance or projected performance influences stock prices. In simplistic terms, let’s say you are investing in a company. If you think the company is going to do well in the future, you may buy more stock.
If you think the company is going to go out of business in the future, you may want to sell. Stock prices go up when more people are buying and stock prices go down when more people are selling.
If a company files paperwork stating they didn’t make as much money as they thought, this can often trigger share owners to sell out of fear the company is going under or is overpriced. The stock price will fall until there is an equal number of people buying and selling the shares.
When more people start to buy than sell again, the price goes up until stockholders are willing to part with their stock. It is a constant up and down as a stock price attempts to level itself out.
What Are Dividends?
Each year on a quarterly or annual basis, profitable companies will either divide up their profits and return some of the money to the shareholders (because they own part of the company) or the company will reinvest the dividends back into the company. Normally only larger companies actually pay their shareholders dividends while newer startups reinvest in an attempt to expand.
I receive annual checks from several companies that I am invested in. Rather than cashing out these checks, I automatically reinvest that money so it continues to grow. Some major companies that pay dividends are General Motors, Kohl’s, Ford, Verizon, and Target just to name a few.
***There are other things that are traded on the market such as commodities like beans, corn, oil, gold, silver, etc. For simplicity sake, I have only discussed companies in this article to avoid getting too far in the weeds.***
For more detailed information on mutual funds, refer to my article: Exposing The Mutual Fund Industry Keep in mind, there are many other factors that influence stock prices but this is an extreme overview if you are new to the stock market.
How comfortable are you with the market? There are many horror stories out there from people who have lost fortunes on the stock market. However, if you invest correctly (in index funds) the stock market will play a pivotal role in your future retirement plans. For more information on retirement, please refer to my related article, Will You Ever Be Able To Retire?
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