What Are Stocks And How They Trade?

Posted: 16 Jan 2008 | Categories: Stocks Mutual Funds

What are Stocks?

You may have heard the word stock and IPO-Initial Public Offering–quite often. You may also have heard people saying that trading in stocks is no better than gambling. The fact of the matter is that trading in stocks is not at all that terribly dangerous. But like in every other business, you need to study and understand the mechanics of stock trading in order to make profits from it.

To explain in a simple way, layman’s language, a stock is the share in the ownership of a company. You may dream of owning a huge company and becoming rich. Although you may not be able to own the whole company, you can purchase a certain percentage of its stock and become its proud owner to that extent. The process can be mathematically explained. Suppose you start a company and issue five shares. Obviously each share would be equal to 20% or one-fifth of the ownership of the company. If, however, you buy another share besides the one you already have, you have two shares and your ownership or stake in the company would rise to 40%. The words stock, equity and share are synonymous to each other. After buying the stock of the company, you can stay with the company as long as it continues paying you dividends and leave it the moment you face losses.

Ordinarily, a stock is physically represented by an attractively designed and important looking piece of paper. It is called a stock certificate. Earlier you had to apply for a share and you would get the stock certificate. The procedure was laborious and time consuming. With the advancement of technology, you do not get the paper certificate. Your stock is held in ’street name’. It means that the stock is held in broker’s name and not in the customer’s name. Doing this allows the ownership to be transferred more easily when a stock is bought or sold. In short, it means that the brokerage firm keeps the records electronically. Otherwise, like in
olden times, you would have to make a trip down to the office of the brokerage to deposit the shares and do the same when selling them.

The basic assumption behind the shares of a stock is that the shareholders are entitled to profits and assets of the company whose stock they own. This is what gives value to your stock. Without this value, your share certificate is a worthless piece of paper and your electronic share remains a worthless computer entry.
Large companies ordinarily issue millions of share and if you happen to own a few shares, it does not mean that you get a ‘free space in their parking lot or, access to the copy machine. If ever you go to their offices, the officials would loathe listening to you despite the fact that you own a small fraction of the company and have voting rights too.

How are the stocks traded?

Stocks are traded-bought and sold-on stock exchanges like the NYSE– New York Stock Exchange, NASDAQ–National Association of Securities Dealers Automated Quotations and AMEX or American Stock Exchange. There are two main types of stock exchanges, physical and virtual.

The physical stock exchanges are like those we see in movies or on the CNBC televisions shows, where the crazy shareholders wearing blue jackets wildly wave pieces of paper in their hands and keep shouting out prices.

The second type, the virtual stock exchanges, consists of actually internet linked networks where the entire trading process takes place online. The reason why the stocks are traded on exchanges is that this is the only best way to make transactions. If you were to buy and sell your shares by placing ads in your local newspaper, you can imagine how slow and tiresome the whole process would be. The exchange is a kind of centralized intermediary between the sellers and the buyers. Obviously the electronic exchanges are more efficient. This explains why even the face-to-face physical exchanges, too, normally use electronic transaction services.

The prices of shares are determined by their supply and demand, just like any other commodity such as wheat or grams. When more people buy a stock, its demand and its price increases. Conversely, when more people want to sell a stock, its demand and its price decreases.

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