How the stock market works: what you need to know

By Binomo

May 9, 2022

Level: Beginner

Reading time: 4 min

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Less than 2.5% of the population of India invests in the stock market. This percentage is very low. This may happen because they are afraid of losing capital. However, risks go hand in hand with significant potential rewards. Even if you are afraid of losses, you should try to trade on the stock market. Start with learning how the stock market works.

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Stock, share, or equity?

When reading educational materials about the stock market, you may be confused by several terms. They’re just synonyms.

A stock is a financial instrument that stands for a percentage of ownership in a company. It represents the right to claim a share of the company’s assets and income.

A stockholder is a person who owns a percentage of the company equal to the number of shares they own. This number is a fraction of the company’s total outstanding shares. For instance, if the company has 5 million shares and the investor owns 250,000 shares, this means the investor has a 5% stake in the company.

Types of stocks

There are numerous types of stocks. Below you will find the basic ones.

1. Dividend-producing stock

Some companies pay dividends; these are rewards to shareholders. The size of dividends is determined by the company and depends on the company’s profit. Therefore, they vary from time to time. Usually, dividends are paid quarterly or every six months. However, this is not a rule. The company could cancel dividends even if it paid them last quarter.

2. Common stock

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Common stocks are the major type of shares. All companies that enter the stock market (hold an IPO) offer them. They provide voting rights so that an investor is allowed to participate in the company’s meetings. The number of votes depends on the number of shares held.

3. Preferred stock

Preferred stocks are optionable stocks. They don’t provide investors with voting rights. However, they grant privileges in terms of paid dividends and assets: investors receive dividend payments before common stock’s dividends are issued. If the company is liquidated, holders of preferred stocks receive payments before those of common shares. Most preferred shares have a fixed dividend.

How does the stock market work? An easy explanation

The stock market is a marketplace where buyers and sellers meet to deal with shares. The stock price is determined by the supply and demand factor. If there are more buyers, the price will increase. If the stock isn’t attractive to investors, the price will decline, as the number of sellers will increase and supply will rise.

There is always a difference between the price sellers offer for a stock and the rate buyers can offer for it. This difference is called a spread. If a stock is sold for $10.25, and buyers offer $10 for it, the spread will equal $0.25.

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How to invest in the stock market

It’s possible to trade on the stock exchange directly only if you have large accounts. However, there are other options that will allow you to invest in the stock market. You can:

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Use an online broker. It’s the easiest and cheapest option.
Use a large bank. Some banks offer investing in the stock market with financial planning.
Work with financial advisors. They usually charge an annual or transaction fee.
Invest in mutual funds. These are companies that buy numerous stocks and hold them in a fund. An investor can buy a share in such a fund. By investing in a mutual fund, you diversify your portfolio and reduce risks, as you own numerous stocks.

Takeaway

The stock market isn’t the easiest or safest investment option. However, it’s one of the major financial markets with plenty of opportunities. If you do comprehensive research, understand how the market works, and find a reliable intermediary that will help you enter the stock market, you have a chance to succeed.

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