Stocks

Stock trading is an immensely popular form of investing, but there’s a mystique about it that makes people wary. Bull market, bear market, blue chips, uptick, downtick--what does it all mean? The majority of the mystery surrounding the stock market is for your stockbroker to worry about, but if you’re considering getting into stock trading, it’s important that you have an idea of what’s going on.

How Stock Works

Any company needs money to operate. The assets necessary for operation are called capital. Raising capital can be as easy as taking out a loan, but the downside of a loan is that it has to be paid back, often with interest. Ideally, a company would want to raise capital that it didn’t have to pay back at all, but donations like that are rare. The next best thing is issuing stock.

Stock certificates represent shares of a company. In return for your investment of capital, you get a share of the return the company gets on that investment. As the company earns money from your investment, the shares you own increase in value. For example, if you buy one share of E.G. Inc. at $10.00 and E.G. Inc. earns $1.00 on that investment, that stock has a 10 percent return. As the return goes up, you can make more money from your investment. There are two ways this can happen: your stock becomes more valuable to people who wish to buy shares in the company, or the company itself pays a dividend to you directly.

Dividends

Some companies offer dividends on their stocks by which a percentage of the earnings that your investment generates is paid directly to you, the shareholder. Dividends are often a small fraction of the actual earnings, but they’re direct income that you can collect while still owning the shares.

Selling Stock

On the other hand, stock in a company getting high returns on investments is often worth more by its selling potential than its dividends. Whereas dividend payments depend on actual earnings, people who buy stock are buying based on earnings potential. The return on investment (ROI) of a stock, such as E.G. Inc.’s 10 percent return in the example above, is the most important part of determining a stock’s worth, but many factors determine the stock’s perceived value in a buyer’s eyes, such as public perception of the company. This is important because like anything else, stock is only worth what someone else is willing to pay for it. There’s no guarantee that you’ll find a buyer for a given stock, but as long as the company is earning money on your investment instead of losing it, there’s a good chance someone will be interested. Even without a buyer, you may be still earning a return, and even if you aren’t, there are buyers who are interested in stocks that decline in value.

Liquidity of Stock

You obviously can’t take your stock certificates to an ATM and cash them out when you want to sell. That’s where your stockbroker comes into play. Buying and selling on the open market are time-consuming and complicated processes that are a stockbroker’s primary functions. For a commission per trade, your stockbroker will handle the transactions for you. It usually takes three days for a sale of stock to settle. Compared to a savings account, stock isn’t very liquid—that is, the funds aren’t immediately available to you—but the earning potential of stock certificates typically trumps the small interest return generated by a savings account.