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So you want to trade stocks, but you’re not quite sure what exactly they are. This post is just a basic rundown that will answer your questions.
Here are four basic points that every investor and trader should know:
In the most basic sense, a stock is a share in the ownership of a company. When you purchase a stock, you become a “shareholder.” This means that you are buying a certificate that represents a claim on the company’s assets and earnings. Don’t freak out though if you don’t get a nice piece of paper like you may have seen in old movies; with today’s technology, you will not be receiving that document from the company. Your brokerage will keep track of these records electronically.
Think of stocks and the stock market as one giant auction. It is a basic example of supply/demand. When there are more buyers than sellers, the stock price will rise to attract more sellers; when there are more sellers than buyers, the stock price will fall to attract more buyers.
People on the sidelines will wait for the right price to place their bid. Example: Company ABC’s stock has 10 sellers and 3 buyers at $10/share. Lets say that 3 of the 10 sellers immediately sell their shares at $10 to the interested buyers, but that still leaves 7 sellers without any buyers. The only buyers are at $9.50/share, so the stock will drop to that price and the sellers will sell their shares to the buyers and the stock price will await further buyers and sellers.
Just like an auction, people will have different ideas of what the shares are worth, so people will be willing to pay different prices for those shares. Expectations have a large impact on what the shares are worth, and these expectations are continuously changing. This is why it is hard to predict future prices. What may seem like a realistic expectation one day, may seem completely off base the next. This comes down to figuring out whether any news regarding the company and/or its industry is positive or negative.
Penny stocks are cheap stocks because they have only a few, if any, products for sale and their business, if any, is just starting. The value of these companies is thus less and so too are their stock prices.
The primary assumption is that the price movement indicates what investors feel a company is worth. Example: Let’s go back to company ABC. Their shares are priced at $10 and there are 1 million shares outstanding, so the company has a perceived value of $10 million.
One of the main forces that impact the valuation of a company is its earnings. These are the profits or losses that a public company is required to report four times a year. This is very logical.
If a company fails to make money, it will not be able to stay in business for a long period of time, and its stock price will suffer. If it makes a lot of money, the company will be able to expand and its stock price will likely rise too as people like to invest in expanding companies with growing earnings.