Understanding How Stocks Work 2024: A Complete Guide

This article explains the basics of investing in stocks in 2024, including how stocks work, the different types and classes of stocks, and how beginners can buy stocks. It also clarifies the difference between often misinterpreted terms such as the stock exchange vs. the stock market and bonds vs. stocks.

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What are Stocks?

Stocks, also called equities, are securities that grant a person percentage ownership of a business or company. These stocks are traded in units, referred to as shares, on popular exchanges such as the New York Stock Exchange, London Stock Exchange, and Euronext Paris. Purchasing a company’s stock gives an individual shareholder status and entitles them to a share of the business’s assets and declared profits, depending on the overall value of their investment.

The concept of stocks dates back to 13th century Europe, albeit in a primitive form when Venetian money lenders began trading debt for securities. This practice, however, has since evolved into what is today known as the stock market, where a single market such as the NYSE has an estimated market capitalization value of $25 trillion.

How Stocks Work

Often, businesses looking to raise funds to scale or expand operations may offer the general public the opportunity to purchase shares in exchange for a stake in the company. This process is generally known as an Initial Public Offering (IPO). Once an IPO commences, investors who may consider a company a good investment can buy shares depending on their available finances and confidence in the growth of their investment’s value.

Stocks can either increase or decrease in price, based on the level of supply and demand for them. However, the overall sentiment regarding the value of a stock can be affected by several factors, including inflation, interest rates, anticipated revenues, trends, and the state of the economy.

Stocks are largely viewed as a high-risk, high-reward investment because, while they can deliver massive profits, they are equally volatile and can drastically reduce in value. Currently, there are over 55,200 listed companies on global stock exchanges, with most of these businesses from the Asia Pacific region.

Types of Stocks

To better understand stocks and how they work, we explain and compare the different types of stocks below.

Common Stock vs Preferred Stock

Common stocks enable investors to gain percentage ownership in a company and participate in several corporate decision-making processes. However, in the event of a liquidation of assets, holders of this type of equity are considered and paid last. Similarly, although they receive dividends the value can fluctuate based on the company’s board’s discretion.

Preferred stocks are higher up in the pecking order after liquidation of assets and guarantee fixed dividends. Investors who own this type of stock are always paid first before considerations are given to common stock owners. Unfortunately, preferred stocks do not confer voting rights.

Growth Stock vs Value Stock

Growth stocks are expected to grow faster than the average market growth rate. Investors who purchase this asset do so based on the expectation that the company is set to experience rapid short-term growth.

Growth stocks do not pay dividends and are generally more expensive than other types of equity. They also offer the potential for higher returns and a higher chance of losses. Since these shares do not accrue dividends, owners can only make gains if the company’s valuation grows as anticipated.

Value stocks, however, are relatively less expensive and are seen as low-hanging fruits. This means they are believed to be trading at a lower price than their actual worth. These equities are less risky than growth stocks but typically provide lower returns. Holding a value stock entitles an investor to dividends since companies that offer these types of stocks are less focused on re-investing their earnings for capital growth.

Dividend Stock

Understanding how dividend stocks work is vital for participating in the stock market. Dividend stocks are securities that allow investors to receive a share of a company’s earnings periodically. The rate of payment of dividends varies from company to company, ranging from quarterly, to bi-annually, and annually. The amount of dividend received by an investor is determined by the total number of shares they own.

Classes of Stocks

There are broadly three recognized share classes – A, B, and C – distinguished by their sales charges and 12b-1 fees. Investors who purchase class A stocks will have the sales fee deducted upfront, at the time of their investment. Class B shares do not incur any initial charges.

However, owners of this type of equity will eventually pay a deferred sales charge, which varies depending on the duration of ownership. Longer periods of ownership usually translate to reduced sales fees. Finally, class C shares command a yearly fee. Each class has unique advantages and disadvantages, depending on an investor’s interests.

How To Invest in Stocks

If you’re looking to invest in the best online stocks, here are a few steps to get you started.

  • Do thorough research on the stocks and the general performance of the sector the stocks belong to.
  • Next, determine the nature of your investment – long or short-term – and how much you’re willing to put in your stock portfolio.
  • Decide whether you wish to invest in real or derivative shares and what markets you want to participate in.
  • After making these decisions,  choose a broker and create an account based on your preference.
  • Buy your preferred stocks on the selected broker and manage your portfolio.

Your choice of stocks and interest in margin trading will determine the financial service provider you use. For example, some brokers may only allow clients to buy US stocks or equities from a particular region, while others offer access to a wider range of foreign exchange markets.

Should I Own Stocks?

Stocks can be an excellent instrument to shield oneself from the effects of inflation. Furthermore, they can provide periodic income via dividends without you having to sell them. Long-term stock investors can also earn massive returns on their initial investment due to capital gains.

Individuals who know how to buy leveraged stocks can also take advantage of the benefits provided by margin investing. However, like any other financial asset, there are no guarantees with shares. Although anyone can own and benefit from buying a stock, this instrument could also lose value over time. It is important to seek proper education and invest with caution.

Stocks vs Bonds

Unlike stocks, which allow investors to claim a percentage of ownership in an organization, bonds are loans given by a government entity or company. This investment accrues a predetermined interest over a fixed period. Bonds are generally viewed as a low-risk investment vehicle compared to stocks.

However, they also offer lower potential for rewards and could also lose value if the borrower experiences adverse economic conditions. Bonds and stocks can be used by companies to raise money and are popular investment assets offered on brokerage platforms. Despite this, they both differ in terms of their nature, potential for returns, and risk nature.

Traders looking to invest in either of these assets can get started by creating an account with a trustworthy broker. Based on our Robinhood, TD Ameritrade, and eToro Reviews, these brokers are among the most popular and reputable companies that offer clients the opportunity to invest in both stocks and bonds.

Stock Market vs Stock Exchange

The stock market is an all-encompassing term describing a collection of stock exchanges where transactions, including the issuance, purchase, and sale of equities are conducted. Stock exchanges are fixed locations where brokers buy and sell shares. For example, the US stock market is made up of two stock exchanges – the New York Stock Exchange and NASDAQ.

The Risk of Investing in Stocks

Stocks are a volatile instrument. People who choose to invest in this asset must be aware of the possibility of a reduction in the valuation of their stocks due to the performance of the issuing company. In some instances, companies could even declare bankruptcy. There are no guarantees of capital gains with prolonged holding of any stock, as this asset could experience devaluation.

Bottom Line

This article is a detailed guide on how stocks work. Investors interested in stocks can choose from different types of stocks, including common or preferred stocks. They can also explore any of the numerous stock exchanges across continents.

Stocks are an excellent high-reward instrument. However, they are also risky and can result in extreme losses. Therefore investors must be aware of the benefits and downside of this asset before purchasing it.

Do you consider stocks an excellent investment option? Share your ideas in the comment box below.

Q & A

Most companies issue shares primarily to raise money for various purposes, including scaling or launching a new product.

There is no fixed yearly growth rate for the stock market. However, average annual growth rates are currently estimated at 10%.

People can lose money when buying stocks but they can also make a profit.

Some of the most popular stocks to buy currently include GOOG, TPR, SPOT, and KHC. However, it is best to do your research before choosing a stock to invest in.

Buying shares can be a safe way to grow money if an investor knows how stocks work and practices healthy risk management. Despite this, like every other asset, investing in stocks also comes with risks.

Several brokers offer recommendations on best-performing stocks. You could also research and identify companies you believe will experience considerable growth and purchase their shares.

You only pay taxes after you’ve sold your stocks.

No, not all stocks pay dividends. For example, growth stocks don’t offer periodic dividends to owners.

You can sell your stocks by placing an order with a broker and waiting for someone else to purchase your shares.

There are many apps to buy stocks. However, Robinhood, TD Ameritrade, Charles Schwab, and eToro are among the most trusted and reputable apps to buy stocks.