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How stock markets work or what mechanisms make them tick - Stock Investing Explained

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by , 11-23-2014 at 12:42 PM (1051 Views)
      
   
Although equity trading has been around in one form or another for centuries, new as well as experienced traders don’t always understand exactly how stock markets work or what mechanisms make them tick.

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The rules of the game have not changed over the years. There are more markets and they are bigger than ever. Computers have cut the time of trade execution down to a millisecond and new companies continue to list themselves on various foreign exchanges. To grasp the concept of what stock trading is all about, we can break down the process into small details and then we can see that it is not really as complicated as we envision.

Borrow or Share


When a company needs to raise money, it has two choices: The owners can take out a loan from the bank or it can offer people a share in the business in the form of shares. As a ‘shareholder’ you own a piece of the business along with many other people. You are a part owner of the company with an entitlement to all assets and all monies earned.

Unfortunately, owning shares does not entitle you to a say in what happens in the running of the company. From time to time, large corporations hold meetings where shareholders can vote on the election of members of the board of directors or on specific changes in the structure of the entity. Usually individual votes have little weight in these issues especially if the number of shareholders is great.

The ownership structure of the company is what contributes to the value to a stock. If stockowners didn't have a claim on earnings, then stock certificates would be worth no more than the paper they're printed on. Investors understand that as a company's earnings improve, the price of the stock goes up. And that is precisely the nature of stock trading.

10% Average Rise


After the New York Stock Market Crash of 1929, the price of stocks started moving upwards and despite many panics and crashes over the years, the average large stock has returned close to 10% a year. However, as with all investments, there are no guarantees. If you stay with large companies that have been around for a good period of time, you have a fairly good chance of coming up on top—if you don’t sell out the moment the stock takes a dip. That is how people end up losing their money. Instead of waiting out the drop in the market, they pull out before the stock has a chance to recover.

The above cannot be said about small cap companies where more vigilance is demanded. Although the buying price is usually lower with smaller companies and one can buy more shares at a low price, the strength and stability are more questionable and the possibility of them going under is great. It’s inviting to move on a “most buy” stock and with the ease of online trading today, making a stock purchase becomes an impulsive move often resulting in a loss.

There will always be both bear and bull markets. Patience and time are the keys to success in investing. Equity trading must be considered a long-term endeavor if it is to be successful. But in order to endure the pain of a bear market, you need to have a stake in the game so when the prices move up, you will be well situated and will be able to make an educated decision whether to sell or stay put.


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