How do stocks work?

Stock investing is one of the most popular ways to invest in equity. While there are more conservative asset classes, only equity has the potential to beat inflation in the long run. However, you need to pick the right stocks to make good money.

This is why understanding the basics and doing thorough research is essential for success. Those willing to invest the time and effort to pick strong businesses are best positioned for success in the stock market.

If you're interested in actively selecting stocks, this guide will help you pick up the core concepts.

What is a stock?

A stock represents ownership in a company. By owning stocks, you have a small part of the company, sharing in its profits and risks. The more shares you own, the greater your ownership.

Owning a stock means you own a small piece of the company. The value of your investment changes based on the fundamentals of the company and its price performance in the market with the latter having a larger role in shorter durations. In addition to potential capital gains when share price rises, some stocks pay dividends, which can provide a regular stream of income.

Private vs Public companies

Private companies are simply the ones that are not listed on any public bourses. They usually have less number of shareholders as compared to public companies.

Public companies, on the other hand, list their shares on stock exchanges, allowing anyone to buy or sell them. These companies are required to share regular financial updates, providing more transparency to investors.

How do companies issue stocks?

Companies issue stocks through an Initial Public Offering (IPO) when they want to raise capital. The IPO process allows the company to sell a portion of itself to the public in exchange for cash, which can be used for a variety of purposes such as expansion, paying off debt, investing in new projects, or even giving a boost to hiring.

Once the IPO is complete, the stock is available for trading in the secondary market, where investors can buy and sell shares. This is where most stock investing happens - on exchanges - National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).

What is the difference between primary and secondary markets?

• Primary market: This is where companies initially offer their stocks to the public through an IPO.
  
• Secondary market: After the IPO, stocks are traded between investors in the secondary market. This is where you'll buy or sell stocks daily.

Suggested read: What are the advantages and disadvantages of an IPO?

How are stocks bought and sold?

Starting with your first investment in a stock isn't as complicated as it may seem. Here's how the process works:

Where are stocks traded?

Stocks are bought and sold on stock exchanges - NSE and BSE in India, NYSE and NASDAQ in the USA. These platforms facilitate the exchange of stocks between buyers and sellers. The trading is done electronically, and price fluctuations are determined by supply and demand dynamics.

Role of brokers and trading platforms

To buy or sell stocks, investors need a brokerage account. There are two main types of brokers:

• Full-Service brokers: They offer a wide range of services, including research, advice, and portfolio management.
  
• Discount brokers: These brokers offer a lower-cost way to trade stocks, typically without the added services that full-service brokers provide.

Brokers act as intermediaries between the investor and the stock exchange. They execute trades on behalf of investors through online trading platforms.

Suggested read: The culture of commissions and why it's a problem

What is the difference between market orders and limit orders?

• Market order: A market order is a request to buy or sell a stock at the current market price. These orders are executed quickly but may not guarantee the price you want.
  
• Limit order: A limit order sets the maximum price you're willing to pay (for buying) or the minimum price you're willing to accept (for selling). This order will only be executed if the stock reaches that price.

How do stock prices fluctuate?

There are a variety of factors that drive share price movement. These include:

• Supply and demand: If more people want to buy a stock than sell it, the price goes up. Conversely, if there are more sellers than buyers, the price drops.
  
• Company earnings: Strong earnings reports can lead to higher stock prices, while disappointing earnings can lead to a decline.
  
• Economic factors: Factors like interest rates, inflation, and employment data can impact stock prices. For example, if the economy is doing well, stock prices generally rise.
  
• Market sentiment: Investor feelings and perceptions about a company or the market as a whole can also drive prices. Positive news about a company or sector can cause a rise in stock prices, while negative news or economic downturns can lead to declines.

How do news and global events impact stock prices?

Stock prices can also be affected by global events like natural disasters, political elections, and changes in government policy. In the age of digital media, news can spread quickly, influencing investor behaviour and stock prices in real time.

How do investors make money from stocks?

Investors can make money from stocks in several ways, depending on their investment strategy:

• Capital appreciation: When the stock price increases over time, investors can sell their shares at a higher price than they bought them, making a profit. This is known as capital appreciation.
  
• Dividends: Some companies distribute a portion of their profits to shareholders in the form of dividends. This provides a steady income stream, which is particularly useful for retirees or those seeking regular cash flow.
  
• Stock buybacks: Companies may buy back their own shares from the market, reducing the number of shares in circulation. This can increase the value of the remaining shares, allowing investors to profit indirectly.
  
• Short-term trading vs Long-term investing
  
• Short-term trading involves buying and selling stocks over a shorter period (days or months) to capitalize on price fluctuations. Traders often use technical analysis to make quick decisions and may look for rapid gains. This strategy is more speculative and carries higher risk.
  
• Long-term investing focuses on holding stocks for several years, benefiting from long-term growth and compounding. Investors typically rely on fundamental analysis, such as earnings growth and company performance. Long-term investing offers more stability and is generally less risky compared to short-term trading.
  
• Speculation vs Wealth-building
  Short-term trading is often seen as speculation, where the goal is to profit from short-term price movements, sometimes based on market sentiment or trends. It carries higher risk and can lead to unpredictable outcomes.
  In contrast, long-term investing is aimed at wealth-building, focusing on the gradual increase in value over time. This strategy relies on the fundamental strength of the company and aims to build wealth steadily, with lower risk and more reliable returns over the years.

Conclusion

Stock investing is an excellent way to build wealth, but it's important to approach it with a clear strategy and an understanding of the risks involved. Start small, invest regularly, and continuously educate yourself on the market. Over time, this path can prove quite lucrative.

Ready to start your stock investing journey? Begin by learning more about the stock market, selecting a reputable broker, and choosing the right stocks for your portfolio. The earlier you start, the better positioned you'll be to build wealth over time!

Also read: Everything to know about stocks

This article was originally published on April 29, 2025.