If you're looking to get to grips with the stock market, it's important to have a good understanding of how everything works before investing your hard earned cash. This guide aims to give you a good base understanding as to what stocks and shares are.
What is a share?
As the name implies, buying a 'share' in a company gives you a share of that company. How many 'shares' a company is divided into varies by company. Imagine that you wanted to open a new shop and required £100,000 to do so. You could divide the company up into 1000 pieces, and then find investors to buy shares at a rate of £100 each – thus giving you the £100,000 needed, assuming you could raise enough interest to attract investors
Profits and Dividends
To explain how payments are earned, let's stick with the same example. If we assume that your business earned £50,000 profit in it's first year, each share owned would be due £50 in profit. This is simply the amount of profit divided by the amount of shares, so 50,000/1000 = 50.
Whether buying in a large stock exchange listed company, or in a small publicly trading company, the principle is the same really; each share you own is a pro-rata piece of that company.
You'll need to enlist the services of a stockbroker, who you can instruct to acquire shares in companies you're interested in. It's the broker's job to match you up with someone selling their shares at an appropriate rate, in order to buy them on your behalf; taking a commission fee for their services.
Rising and Falling Share Prices
The stock market is nothing more than a constant auction really, with investors making decisions in real-time. If someone wants to sell their shares in a company and there are no buyers, the price will begin to fall until someone steps in to buy the shares. If a large investor dumps their shares on the market in one go, the supply is likely to dwarf the demand and this drive the price lower. The opposite is also true where a large amount of stocks are bought in a short space of time – the demand is higher than the supply and so the price should rise.
It's a common misconception that to succeed in the stock market you have to buy stocks at a low price and sell for a high price, but this is not strictly true. Whilst clearly it's not good to lose money on shares you've bought, the success of your investment is ultimately dependant on the profit it generates – that's to say if the business is still making money and you're receiving dividend payouts, you're no worse off than previously unless you need to dump your shares for some reason. Many investors actually look at such incidents without emotion as it gives them a chance to buy a greater amount of shares in a profitable company, at a reduced rate.