If you have never invested in stocks, you are probably leary about doing so now. The recent COVID-19 (Novel Coronavirus) pandemic and the associated social and economic turmoil have resulted in an unstable investing environment. However, once this perilous time is over, there are some essential things you will need to know about different types of stocks and how the stock market works. Here are some of the basics.
What are Stocks?
Stocks, also known as shares (although technically different), are among the most popular, accessible, and best forms of investment. Stocks are securities in a company that investors (shareholders) buy to gain ownership of the cash assets or profits of a company. The shares of stock represent a particular percentage of ownership in a specific company's profits. The company gives the shareholder a cut of the profits according to the number of shares owned. Companies use stocks as a way to raise the capital required to grow the business from the public. Stocks are represented by either a paper or digital stock certificate, which indicates proof of ownership.
Popular Types of Stocks
The two major types of stocks include preferred and common shares.
For common stocks, the shareholders' dividends (distribution of profits) vary depending on the returns of a particular company when the company is doing well financially. Shareholders have voting rights, and their shares are not redeemable or cannot be repurchased by the company. During the liquidation of the company, their payment comes last. However, by accepting this risk, they stand to make higher returns on their investment when the company makes immense profits, unlike other types of stocks.
Preferred stocks are stocks in which a shareholder receives a fixed return on the capital invested. These shareholders do not have voting rights hence categorized as financiers and not owners of the business. Lack of voting rights means that they do not have a say in decisions that might affect the profitability of the company. A shareholder can redeem their shares at any time. During liquidation, their payment comes first, thus does not suffer a risk of losing their capital.
Share classes are also another additional type of stock provided by some companies. The company groups shareholders in different classes, for example, Class I and Class II. Grouping of various shareholders in different share classes are based on their voting rights. Class I may have more voting rights than Class II.
What is a Blue-Chip Stock?
A blue-chip stock is generally a huge public corporation with an excellent reputation on its dividends and profits payments to investors. In most cases, in the sector they operate in, these companies are the leading investors in terms of their financial stability and returns. These companies survive challenging market cycles, making them a good investment option for investors. Some of these companies include Coca-Cola and IBM Corporation. The long records of paying stable dividends and profits to investors make blue-chip stocks a popular form of investment.
How Does the Stock Market Work?
The stock market operates like an auction house where buyers and sellers come in and negotiate prices of different stocks available before trading. Generally, the market runs through a network of exchanges like the New York Stock Exchange, Nasdaq, London Stock Exchange, and the Shanghai Stock Exchange.
Through a process known as Initial Public Offering, companies provide the sale of its stocks to the general public to raise capital for their business. The buyers and sellers trade the stocks on their own in what is referred to as an Open Market. The levels of demand and supply determine the pricing of stocks and other securities. A bid price is the highest amount a buyer is willing to buy a stock, whereas ask price can be defined as the peak price a seller is ready to sell a stock. This difference in price is known as the bid-ask price.
When you hear the term Bear Market in stocks, that is referring to a stock market condition in which securities prices fall 20% or more from recent highs. The term Bull Market refers to a situation when stock prices rise 20% or more over an extended period and from a near-term low.
How to Invest in a Stock
Stock investments carry a high level of risk, but high returns; thus, investing in stocks requires high-level skills and a good understanding of the stock market and the company in which you are investing. One can purchase individual shares through persons at brokerage firms or by using electronic trading platforms offered by online brokerages or websites.
Before opening an account with an online broker, you should confirm their certification, commissions, or spreads charged and their reputation to avoid fraud. Exchange-traded funds and index funds provide one with a platform to invest in multiple stocks (portfolio of stocks) at once. The goal of acquiring shares of stocks is to buy a stock at the least possible price and sell it at the highest price.
Differences Between Bonds and Stocks
Stocks are a form of ownership of profits, whereas bonds are a form of debt issued for repayment at a specified future date. Shares of stock carry a potential higher risk to issuer than bonds since relationships ensure that the issuer gets back the value of the equity at maturity. Bonds gain fewer returns as compared to stocks. However, investors prefer them during the stock market recession. For stocks, the investor suffers risk of losing their money during a recession.
Common Terminology Associated with Stocks
- Broker – a person or entity who buys or sells stocks in your behalf
- Dividend – company earnings paid out to the owner of shares, often on a periodic (quarterly) basis.
- Shareholder – a person, company, institution, or other entity that owns shares in a company.
- Bear Market - a stock market condition in which securities prices fall 20% or more from recent highs.
- Bull Market - a condition when stock prices rise 20% or more over an extended period and from a near-term low
- Security – a financial asset that is tradeable and holds some type of monetary value. Stocks are a type of security.
- Portfolio - a collection of stocks and other investment
The stock market is among the best long-term investments due to its high returns on capital. For one to become profitable in trading stocks, the proper understanding of how the market works is vital. There are online learning platforms and also institutions offering learning programs on how the market works. Most investors have strategies and specialized tools they use when executing short-term trades, allowing them to have an edge in the securing of trending stocks.