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How the Stock Market Works

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As a newbie trader/investor, stock market terms can be overwhelming. Before you dive into the stock market and invest your hard-earned money, it is important first to know the terminologies associated with the said market.

What is a stock?

Stocks, also known as equity or shares, are a form of investment capital that represents a shareholder’s claim to a piece of a company or corporation’s assets and earnings. The terms company’s assets and earnings mean what it owns and gets from the gains or profits.

How does it work?

By selling stock, the stock market facilitates capital formation for businesses and the creation and maintenance of wealth for investors.

To raise capital, businesses often sell shares of stock to market participants. Shares of stock are the common name for these ownership interests.

Rather than taking on debt to fund operations and growth, firms can get the funds they need by listing their shares for sale on the stock exchanges that make up the stock market. Companies that wish to offer stock to the public are obligated to provide certain levels of transparency and shareholder representation.

What is meant by “shares”?

The stock market is useful for investors because they can convert their money into shares. Shareholders realize capital gains as their initial investment in a company is used to fuel its future growth and expansion. Additionally, dividend payments are distributed to stockholders as a company’s profits increase.

The percentage of ownership in a corporation that a shareholder can claim is directly proportional to the number of shares of stock that person holds.

A 10% investment in a corporation with 1,000,000 outstanding shares would be held by an individual or group that owned 100,000 shares. In many large corporations, the number of issued shares is in the millions or even the billions.

Differences between the two stock types 

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Common shares and preferred shares are the two types of stock in circulation.

Market value and trading volume

Since common shares have a much higher market value and trading volume than preferred shares, the term “equities” is used interchangeably with “common shares.”

Voting rights

In most cases, a shareholder holding common stock will also have voting rights, allowing them to participate in shareholder meetings and elections, while a shareholder holding preferred stock will not. In the case of a liquidation or dividend distribution, holders of preferred shares will receive those funds before common shareholders will.

Voting rights structure

The voting rights of common stock are a separate category. Even though one vote for each share of common stock is the norm, some corporations have two or more types of stock, each with different voting rights.

Class A shares may have 10 votes per share, while Class B shares may have 1 vote per share in a dual-class structure like this. The purpose of dual or multiple class share structures is to give the company’s founders a greater say in its future and its ability to make strategic decisions and implement innovations.

Reasons why you should invest in the stock market

Owning stock in a corporation means making money when the firm makes money. A tremendous return on investment and substantial gains are possible if you select strong businesses to place your money.

For financial stability

This could be a fantastic strategy to secure financial stability for yourself and future generations. The best gains, over time, can be found in the stock market. The stock market is better than gold, bonds, and real estate.

For building passive income

Most of us can’t afford to keep working forever, so we have to find other ways to bring in money once we stop actively looking for work. The earlier you start investing, the sooner you can retire, and the more wealth you can accumulate and generate in the form of passive income.

You can use stock market investment as a means to generate passive income. Passive income allows you to maintain your current standard of living with minimal additional work.

How to start investing in the stock market

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Most people already have some exposure to the stock market through their retirement savings accounts. Most retirement accounts offer mutual funds, which are collections of several equities.

Find a broker or financial advisor.

Single stocks are also available for purchase. You should register for a brokerage account online broker. Some financial experts are willing to lend a helping hand to those who seek advice. Based on your objectives and risk tolerance (how much you are willing to lose if your stocks don’t do well), they will advise you on the best online brokerage to utilize.

Know the risks in investing

The choices above all act as intermediaries between you and the stock markets. Put another way; you may have to pay commissions to your broker or financial advisor if you want their assistance buying stocks.

In addition, you should be aware that there is always the chance of incurring losses and the possibility of gaining profits when investing. That’s why weighing the benefits and drawbacks is important before settling on a course of action. Stocks and mutual funds are great options for the long run.

Risks in stock market investing.

An investor runs the greatest danger of losing everything in the stock market if the price of a stock they own drops to zero, as could happen if the firm in which they have invested goes bankrupt.

There is a risk of financial loss while trading equities. Some people think day trading is dangerous since you can never be sure you’ll come ahead. In contrast to short-term trading, long-term investing in the stock market may prove more profitable, but you still need to be mindful of the dangers of market crashes.

Market crash risk

A market crash occurs when the stock market’s value drops by more than 10% but is less than 20%. A severe market decline could potentially trigger an economic downturn.

Bear market risk

A bear market occurs when the stock market drops 20% from its all-time high. Any asset class is vulnerable to a bear market, which can wipe away years of profits.

Pros in stock market investing.

  • Buying and selling shares can be conveniently done online
  • For starters, stock market values can rise alongside the economy, and if you time your trades correctly, you can earn a healthy return on your money.
  • It’s convenient to trade stocks online and helps you beat inflation if you’re investing for the long haul.

Cons in stock market investing.

  • The market’s volatility can put your capital at risk, and there’s always the chance that the business in which you’ve invested will fail, wiping out your entire investment.
  • Because of the volatility in stock prices, making short-term gains in the stock market is challenging.
  • You’ll have to spend considerable time learning about different businesses and tracking stock prices.

Alternative markets

The term “stock market” is commonly used to describe the many exchanges and markets where equity shares and other assets are exchanged. There are separate marketplaces for various other forms of financial assets.

OTC markets

“Over-the-Counter” (OTC) refers to markets where securities are bought and sold without a centralized exchange. The prices of OTC trades are not often readily available to the public, as they are typically conducted privately between sellers and purchasers. Over-the-counter trading occurs for most bonds and a sizable portion of equities, including penny stocks.

Commodities markets

Commodities markets facilitate trading of raw materials such as steel, coal, and oil. Around fifty major commodity markets exist across the globe, allowing for the trading of a vast array of products.


Derivatives, such as options, are financial instruments derived from another asset’s value. These are legally binding wagers on the future price movement of specific securities. Derivatives provide seasoned investors a means to reduce risk while making a profit, but they are not for the faint of heart.


Foreign exchange (Forex), or Forex trading, is a currency exchange between two parties located anywhere in the world. Forex traders earn from the rapid price changes in currency pairs by providing a source of liquidity for global commerce. The trade takes place between buyers and sellers around the globe. Traders benefit from the price difference between two currencies by anticipating and acting on price changes.


Cryptocurrencies like Bitcoin and Ethereum are traded on crypto exchanges.


When assessing the state of the economy, analysts frequently look to stock prices as a proxy for the vitality of the stock market. However, the stock markets’ significance extends far beyond simple gambling. Public firms rely heavily on the cash provided by the stock market since it allows them to raise large sums of money by selling shares to hundreds of millions of individual investors.