The Basics of the Stock Market

The stock market is a key part of the financial system that allows everyday people to invest in some of the world’s most successful companies. However, before you jump into stocks you should understand the basics about how they work.

A stock is an ownership share in a publicly traded company. A company issues shares of stock to raise money, and then they are sold on the stock market. Investors buy and sell them for a variety of reasons, including the potential for long-term capital growth, the opportunity to profit from shorter-term stock price movements and the chance to receive dividend payments.

Investors use their own research to determine the value of a particular stock and then decide whether to buy or sell. They can use the same analysis that Wall Street investors employ, such as studying a company’s financial results to make valuation estimates and set price targets. Investors can also use online tools to research and compare stocks. Many investors build diversified portfolios of several types of stocks to minimize the risk of losing all of their money if one company’s shares plummet.

A company might issue new shares of stock to raise money for a variety of reasons, such as to expand its operations or undertake a new project. The company typically sells the shares in the primary market through a process called an initial public offering, or IPO. Investors can then purchase the shares on the secondary market, where they can be bought from another investor or from the company itself.

When you own stock in a publicly traded company, you own a tiny fraction of the company. You are not entitled to a parking spot in the company lot or to rub elbows with the corporate bigwigs at shareholder meetings, but you do have a voice in how the company is run. Some shareholders are able to vote in elections for management and directors, and some receive annual dividends from the company’s profits.

Stock prices are affected by events within and outside of the company, such as a product recall or a slowing economy. Thirty-nine of the forty-two recessions that the United States has experienced since 1802 have been preceded by a fall in the stock market. During a recession, the stock market usually falls by about 10 percent or more, but it takes six months to a year for the economy to follow suit.

Over the long term, stocks have historically outperformed bonds, which are debt securities issued by governments and other institutions to finance projects and businesses. This historical return is a result of a combination of things, including higher potential earnings from growth and the possibility of receiving dividends. However, you must realize that stock prices can rise and fall, and even the largest companies have lost value at times. This is why prudent investors build diversified portfolios of stocks from many different companies across multiple industries and geographies. In addition, you must plan to hold your shares for a long time to be able to benefit from long-term returns.

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