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Stock trading is one of the most well-known forms of financial trading.
In this lesson, we’ll cover what stocks are, how the stock market operates, and the key points to understand before you begin.
Stocks, also known as shares or equities, represent ownership in a company. When you buy a stock, you own a small part of that company, making you a shareholder.
Being a shareholder comes with certain benefits, like earning dividends (a share of company profits) and sometimes having voting rights in company decisions.
Example: Imagine a local gym divides its ownership into 100 shares and sells them to the community. If you buy one share, you own 1% of the gym. As the gym grows and makes more money, the value of your share increases. Stocks work in a similar way.
Here are some important stock-related terms to help you navigate the market:
Dividend: A portion of a company’s earnings paid to shareholders, often quarterly.
Bear Market: A period when stock prices are falling, usually due to economic downturns.
Bull Market: A period when stock prices are rising, typically during strong economic growth.
IPO (Initial Public Offering): When a private company sells shares to the public for the first time.
Market Capitalization: The total value of a company’s shares in the market, indicating its size.
Index: A benchmark like the S&P 500 or Dow Jones, used to measure stock market performance.
Stocks come in different types, each with unique characteristics.
Here are the main ones:
Common Stocks: The most widely traded type of stock. Holders have voting rights at shareholder meetings and may receive dividends, although payouts are not guaranteed. If the company does well, common stockholders can benefit from rising stock prices.
Preferred Stocks: These stocks typically don’t offer voting rights, but they come with guaranteed dividends that are paid before common stock dividends. If a company goes bankrupt, preferred stockholders get their money back before common stockholders.
The stock market is where stocks are bought and sold. It operates through exchanges like the New York Stock Exchange (NYSE) and NASDAQ.
Companies list their stocks on an exchange through an IPO (Initial Public Offering), allowing investors to buy and sell shares. Prices change based on supply and demand, if more people want a stock, the price goes up; if more people sell, the price drops.
Example:
Company X goes public and offers shares at $10 each.
Person A buys 100 shares for $1,000.
Over time, Company X grows, and its stock price rises to $15 per share.
Person A sells their shares for $1,500, making a $500 profit.
The stock market is a dynamic place, and prices fluctuate based on company performance, investor sentiment, and economic conditions.
Stock prices change constantly due to various factors:
Company Performance: Financial health, profitability, and growth prospects.
Market Trends: Overall trends in the stock market or the economy.
Investor Sentiment: Investors' perceptions and expectations about the future.
Stock prices are also influenced by a mix of fundamental (financial reports, earnings) and technical (price trends, charts) factors. Short-term traders often rely on technical analysis, while long-term investors focus on fundamental analysis to assess a company’s value.
Stock prices don’t move randomly. Several key factors influence market trends. Let’s go over the biggest ones:
When the economy is booming, businesses make more money, people spend more, and stock prices tend to rise. During recessions or high unemployment, stock prices often drop as investor confidence weakens.
When central banks raise interest rates, borrowing money becomes more expensive, and businesses slow down, often causing stock prices to fall. Lower interest rates, on the other hand, encourage spending and investing, which can push stock prices higher.
Every few months, companies report their profits. If a company makes more money than expected, its stock price usually goes up. If earnings disappoint, stock prices can drop as investors rethink their expectations.
Elections, trade wars, natural disasters, and major global events can shake up the market. Political stability and positive trade deals generally boost stock prices, while uncertainty or conflicts can cause panic selling.
Sometimes, emotions drive the market more than logic. If investors feel optimistic, they buy more stocks, driving prices up. If fear takes over (due to bad news or uncertainty), they sell off stocks, leading to a market drop.
Stock exchanges are the marketplaces where stocks are bought and sold. They provide a structured environment for companies to list their shares and for investors to trade them securely.
Some of the most well-known stock exchanges include:
New York Stock Exchange (NYSE): The largest stock exchange in the world, known for listing blue-chip companies.
NASDAQ: A technology-heavy exchange featuring companies like Apple, Amazon, and Tesla.
London Stock Exchange (LSE): One of the oldest stock exchanges, listing many European companies.
Tokyo Stock Exchange (TSE): The largest stock exchange in Japan and home to major corporations like Toyota and Sony.
Stock exchanges operate through an electronic system where buyers and sellers place orders. These orders are matched based on price and availability.
There are two primary types of markets:
Primary Market: Where companies issue new stocks through an IPO (Initial Public Offering). Investors buy directly from the company.
Secondary Market: Where investors trade stocks among themselves. Once a stock is listed, it is bought and sold on the secondary market.
Example: If a company launches an IPO, its shares are sold on the primary market. After the IPO, those shares trade between investors on the secondary market through exchanges like the NYSE or NASDAQ.
Benefits:
Potential for high returns over time.
Ability to build wealth by investing in successful companies.
Stocks are liquid, meaning they can be bought or sold easily.
Risks:
Stock prices can be volatile, leading to potential losses.
No guaranteed returns, prices fluctuate based on market conditions.
Investing without research can result in poor decisions.
Tip: A smart way to reduce risk is by diversifying, spreading investments across different stocks and industries.
As we approach the end of the lesson, here’s how to start trading stocks as a beginner:
Open a Brokerage Account: Choose a reputable brokerage firm and open an account. At the end of this course, we’ll explain the importance of choosing a reliable broker for online trading.
Research Stocks: Before investing, research the stocks you're interested in to understand their potential risks and rewards.
Start Trading: Buy stocks through your brokerage account, keeping in mind your investment goals and risk tolerance.
Stocks represent ownership in a company, and buying them makes you a shareholder.
There are two main types of stocks: common stocks and preferred stocks.
The stock market is a place where stocks are bought and sold.
Company performance, market trends, and investor sentiment influence stock prices.
The benefits of investing in stocks include potential high returns; risks include price volatility.
To start trading, open a brokerage account, research stocks, and begin buying and selling according to your investment strategy.
In the next lesson, we’ll explore Forex trading, the largest and most liquid financial market in the world.
Our easy-to-use glossary breaks down complex trading terms into plain English. Learn the key terms every trader needs to know.
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