What Are Stocks?
When a company needs to raise funds, for example, to grow or pay back debts, it will sometimes sell off a small share of its assets. This share is called a stock. While stock owners, or shareholders, are technically entitled to give their opinion on who should run the company, most individuals do not own a big enough piece of the business to make major decisions. The primary benefit of owning a company’s stock is that that the shareholder expects that the company as a whole will be worth more in the future, and therefore can be sold at a profit. The general trend is that companies do increase in value over time, partly because inflation naturally leads to higher prices for goods and services. Additionally, because there is always a chance that a company could under-perform, or even go out of business, this risk is built in to the stock price, and the historic returns on stocks have averaged approximately 11%, which is more than triple the returns on more stable investments such as bank savings or municipal bonds.
How Are Stock Prices Decided?
Stock prices are usually decided by a central exchange. This exchange can either be at a physical location, such as the New York Stock Exchange (NYSE) which is located on Wall Street in New York City. It can also be a virtual exchange like the NASDAQ where computers trade stocks electronically. Having one location where buyers and sellers can come together helps make trading stocks easier. While the NYSE is home to the largest stock exchange, there are several spreads throughout the world, including major centers in London and Hong Kong.
Stock trading is managed like an auction. An intermediary looks for pairs of buyers and sellers and tries to match up those willing to pay the most for a given stock with those willing to accept the least for the same stock. The stock price changes with each successful transaction.
The price for a stock is based upon how much confidence people have in the company. When the company seems to be doing well, more people will want to own a part of it. This makes the stock harder to come by, and people need to pay more to get it. When a company inspires less confidence, people will no longer be excited to own it, and sellers will drop prices until the stock seems like a bargain.
The main indicator of how well a company is doing comes in the form of earnings. Companies that participate in the stock market are required to issue regular reports stating how much profit they have generated. Analysts make estimates of how much profit companies should be making, and compare these projections to the actual numbers released every three months. Then Investors review these comparisons and decide if the company is doing better or worse than expected. This can lead to interesting situations where a business is turning a profit, but experiences a stock price drop, because the market expected the company to even better than it was. Conversely, some companies that are actually losing money may see a stock price bump if the quarterly earnings reports reflect a better performance than analysts predicted.
What Are the Risks of Trading Stocks?
Stock trading can become complicated because there are a lot of hidden costs that need to be taken into consideration. Most traders need to buy stocks through a broker, who generally earns income in the form of a commission, a small per transaction fee. Also, companies sometimes give small trade compensations that need to be calculated for each share, and investors need to keep track of all of these items for accounting purposes. Stock trading can also lead to the loss of more than your initial investment.
One way to minimize the risk of trading stocks is to switch to CFD trading. This allows you to simplify stock trading down to whether a stock price will go up or down, without having to worry about paying a third party an extra fee. Rather than purchasing stocks, you make a contract determining the direction the stock value is going to take and collect profit on the difference. The amount you need to invest is a lot lower, yet the profit is the same.