How the stock market works

If you want to understand how the stock market first, you need to begin by familiarizing yourself with the terminology. A lot of people are highly stressed when they want to learn more about how the stock market works and do not devote any time to learning the basic. This is a problem, because you may very well make a few lucky investments in the stock market without knowing anything about the underlying factors, but without any basic knowledge it is very difficult for you to really understand how the stock market works. It will for instance be difficult for you to determine the various ways in which a sudden incident might affect the stock market in the long run, or how to read a report and make assumptions based on the figures.

What is a stock?

A lot of people claim to know how the stock market works, but if you ask them simple questions such as “what is a stock, really?” they will soon reveal how shallow their understanding of the stock market really is.

In financial markets, stock is the capital raised by a corporation (or by a so called joint-stock company) by issuing and distributing shares. If you hold at least a partial share of stocks, you are a shareholder (also referred to as stockholder). Stocks can be held by individuals as well as by companies, including corporations.

Listing a company on the stock market is a way of brining money into the company. Once a company has listed itself on the stock market, it will be expected to strive to increase shareholder value. Understanding why companies choose to list themselves on the stock market is one of the keys in understanding how the stock market works.

What is a shareholder/stockholder?

As a shareholder/stockholder, you will be granted special privileges which in turn will depend on your class of stock. You can for instance be allowed to vote on important matters such as board elections, have a right to a specific share when company income is distributed, and have a right to a share of the assets if the company is liquidated. You can also be entitled to purchase new shares. Common stock, preferred stock, dual class stock, treasury stock and golden share are all examples of different types of stock that comes with different sets of rights for the shareholder. If you want to fully understand how the stock market works, you should ideally do some reading on these different types of stocks.

Being a shareholder doesn’t simply mean having the right to a share when everything goes well; it also means having a share in the problem when things turn bad. Unfortunately a lot of people think they know how the stock market works, but they have failed to grasp this simple truth.  As mentioned above, shareholders typically have the right to receive company assets if the company is liquidated. This right is however subordinate to the rights of creditors, and you will therefore only receive assets once all the creditors have been paid of. Since companies that undergo liquidation typically are deep in dept or have very limited assets, you cannot expect to receive anything in the event of liquidation. The good thing is that you will only loose the amount of money you used to purchase your share; the creditors can not take anything else from you (as long as you haven’t done anything illegal). This is how the stock market works.

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