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By: rkapur
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Stock Market 101: What Is the Stock Market and How Does It Work?

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One of the primary functions of a stock market is that it allows investors to buy shares in a company. The stock market also operates as a place to sell the shares you own as well as transact in other financial instruments.

The actual process of buying and selling shares is conducted in a stock exchange.

The biggest exchanges in the country are the New York Stock Exchange (NYSE) and Nasdaq. In fact, the NYSE and Nasdaq are also the largest stock exchanges in the world.

The purchase and sale of shares cannot be carried out directly by investors at a stock exchange. Instead, you need to go through a stockbroker. A stockbroker is a licensed professional who acts as an intermediary between an investor and the stock exchange. It’s essential to open an account with a broker before you can start trading in shares.

Before we get into the details of buying and selling stocks, let’s take a moment to understand what the term “stock” means.

Remember that the words “stock” and “share” are used interchangeably. For all practical purposes, the two words mean the same thing. They both denote ownership in a company. So, if you buy, say, 100 shares in Amazon, you own a small part of the e-commerce giant. Of course, a hundred shares represent only a tiny fraction of the total. Amazon has issued about half a billion shares.

Understanding the Basics – Reading Stock Prices

Stock investments can be highly profitable. Investors gain in two ways. One, the price of a company’s share may rise after you make a purchase. You can sell the stock, and the difference between the purchase price and the selling price is your profit.

The other way that investors benefit is that they are entitled to the dividends that companies pay. The dividend is the share of profit that an investor gets from the company. It’s essentially a reward for investing in the stock.

Here’s an example that illustrates how profitable buying stock in a company can be. An investor who had the foresight to buy Amazon stock five years ago would have purchased each share at $331. Today the stock trades at more than $1,838 – a return of 455% in five years!

Bear in mind that a company is not required to pay dividends even if it is making a profit. For example, Amazon has never paid a dividend.

New investors should devote some time to understand how to read stock prices. Here’s a screenshot of a stock quote for Amazon:

Source: TheStreet

An explanation of Amazon’s stock quote

The letters AMZN represent the stock symbol for Amazon Inc. This is a unique series of letters assigned to each security. Stock symbols are also referred to as “ticker symbols.”

The numbers 1,838.44 denote the price of the stock in dollars. Figure 18 with a small arrow to its left next to the price indicates that Amazon’s share has gained $18 during the day.

The information in the two columns on the right side of the stock quote reveals the following details:

  • Prev Close: The price at which Amazon’s stock closed on the previous trading day.
  • Open: The price at which Amazon’s stock opened on September 12, 2019.
  • Day Low/High: The price range in which the stock has traded on September 12.
  • 52 Wk Low/High: The price range in which the stock has traded in the last 52 weeks.
  • Volume: 2.43 million shares have exchanged hands during the day.
  • Average Volume: The average number of Amazon shares that are usually traded in a day. This average is usually calculated over 20 or 30 days.
  • Exchange: The data is from the Nasdaq exchange.
  • Shares Outstanding: This is the total number of shares held by all the company’s shareholders.
  • Market Cap: Market capitalization refers to the total value of the company. It is calculated by multiplying the number of shares outstanding by the market price.
  • EPS: Earnings per share. This refers to the profit attributable to each share.
  • P/E Ratio: The price of the share divided by the company’s EPS.
  • Div. & Yield: Amazon has never declared a dividend.

What’s the Difference Between Stocks and Options?

You will often hear the word “options” in the context of stock trading. It’s important to understand the difference between stocks and options.

When you buy a stock, you become the owner of a small part of the company that has issued the stock. An option, on the other hand, is a contract that gives you the right to buy or sell a stock at an agreed-upon price within a specified period.

There are two broad types of options:

  • A call option gives you the right to buy a stock.
  • A put option gives you the right to sell a stock.

Should you invest in stocks or purchase options?

Options offer several advantages. They can be far more profitable than stock investing. That’s because a relatively small movement in the price of the underlying stock can provide a significant return.

Want to learn more about options? Read our post Options vs Stocks: What Should You Choose?

Should You Invest in the Stock Market?

The stock market has the potential to make you very rich. Have a look at the performance of the Dow Jones Industrial Average, an index that indicates the value of 30 large publicly owned American companies.

Performance of the Dow Jones Industrial Average (DJIA) over 10 years

 

Source: Macrotrends

A glance at the chart shows you that the Dow Index has followed an upward trajectory over the last decade. However, there have been many ups and downs.

What does this tell us? You must understand two things:

  • When you buy a stock, there’s no guarantee that its value will rise. In fact, it may plunge soon after you make the purchase.
  • The Index itself may suffer a decline. Of course, the average of the prices of the 30 stocks that comprise the Dow Index has risen in the last ten years. But in the short term, stock valuations could fall resulting in a decline in the Index.

If you are willing to stomach the risk of seeing a fall in the price of the stocks that you have purchased, go ahead and invest. The upside can be high.

Is it a Good Time to Invest in the Stock Market?

Stock markets are currently near their all-time high. It’s possible that the market may move downwards after you make your investment. If this happens, you must be willing to commit your funds for the long term as it may take time for the market to rise again.

What if you don’t want to risk your money in stocks?

An alternative to stock investments

Many small business owners prefer to deploy their excess funds in their companies. An infusion of money can help you to expand operations and increase profitability. What if your business needs cash, but you don’t have excess liquidity?

Fortunately, there’s a way out.

At Camino Financial, we provide small business loans up to a value of $400,000. Want to know if you prequalify?

Complete our online form and find out immediately. Our motto is “No business left behind.” Our loan specialists will help you raise the sum you need at the best possible interest rates.

What are the Requirements to Invest in the Stock Market?

Ready to start buying stocks? Here’s a checklist that you can use:

  1. Open a brokerage account: Refer to our post What Is a Stockbroker and How o Find One.
  2. Fund the account that you have opened. Some firms require a minimum sum to be deposited. Others like Bank of America’s Merrill Edge offer a $0 account minimum option.
  3. Start buying stocks by placing an order with your broker. You may like to read How to Invest in The Stock Market before you make your first investment.

Are non-U.S. citizens allowed to buy stocks in U.S. companies? This question could be of great relevance to small business owners who don’t hold U.S. citizenship.

Currently, no law requires investors in the U.S. equity market to be citizens of the country. However, you do have to remember that you need a brokerage account. To open one, you would typically require a Social Security Number, a valid mailing and email address, and proof of your annual income.

How Much Does it Cost to Buy and Sell Stocks?

There is a cost associated with buying and selling shares. Most brokerage firms will charge you per trade or per share. How much should you expect to pay? Here’s what some of the most popular broker’s charge:

Brokerage Commission payable
Merrill Edge $6.95 per trade
TradeStation $5 per trade
Charles Schwab $4.95 per trade
InteractiveBrokers $0.005 per share subject to a minimum of $1 per order
Robinhood $0

The Bottom Line

The legendary investor, Warren Buffett, who’s worth $82 billion and is the third-wealthiest person in the world, has this to say about stock investing, “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.

Now, that seems obvious. The stock market can be very profitable if you can follow Warren Buffett’s advice.

However, for many small business owners, it may be far better to do what they know best – run their companies well and expand the level of operations. If you require assistance to do this, we, at Camino Financial, will be only too glad to help. Our motto, “No business left behind,” is the guiding principle for our loan specialists and they will do their best to assist you in raising money for your firm.

You can receive the funds from a small business loan from Camino Financial directly to your bank account within just a few days of applying. Contact us to learn more and start growing your business today safely and steadily.

 

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