The stock market is one of the fields that confuse many people, with some considering it as some sort of legal gambling. They think it is a short-term investment that can result in either huge gains or catastrophic losses. How exactly does the stock market work?
To have a better understanding of the stock market, it is good to know the common terms used in the industry. One of them is a ‘share.’ This is just what its name indicates-a share of the company concerned. People invest in shares that give them ownership in the companies, which entitles them to some fraction of the earnings and assets of the company. This brings us to other terms.
Assets refer to all the things the company owns, including equipment, buildings and trademarks. On the other hand, earnings refer to the money the company receives through the sale of its products or services. People who invest in the stock market are known as stockholders. For the stockholders to own shares in a company, they need to buy stocks and then expect the company to pay them dividends annually.
The stock market exists because companies have to raise the money they need to run their businesses. The other option of getting the required money is through borrowing but this method has some drawbacks. For example, the money borrowed must be repaid within a given timeframe and the borrower must pay interest.
Therefore, a company can decide to sell its shares instead to raise the required capital. The company will not be required to repay the money, let alone paying interest on it.
It creates a win-win situation for both parties. Stockholders get the opportunity to own part of a larger company and get dividends in return. On the other hand, the company gets the money it needs with relatively few complications.
Supply and demand drive the stock market. A company may decide to sell more shares to lower the price of each share and the number of shares will determine the supply. The number of shares stockholders are prepared to buy will also determine the demand for the shares.
The stock market resembles a large automated store where people engage in the sale and purchase of stocks. Whenever someone buys a share, another person sells that share.
This superstore operates in an exchange where sellers and buyers are matched to set share prices and facilitate trading. Examples of major exchanges include the New York Stock Exchange, Nasdaq and all electronic communication networks.
The value of stock is determined in two primary ways. One method is by analyzing fundamental earnings, sales or cash flow. The other method involves the amount of money stockholders are prepared to pay for stock shares and for how much the selling investors are ready to part with their stocks.
While many people think the stock market is a short-term investment, the fact is it works better as a long-term investment. This is when short-term fluctuations will not have too great an impact in the investment. Fear and greed are the predominant drivers in short-term investments. In the long term, however, the main drivers include financial, economic as well as global growth.