What are stocks?
How does the stock market work?
As someone who is pursuing a career as a day trader, I feel like I need to start from scratch and review all the basics.
So this is my stock market review page.
I want to keep this short and to the point. Links within the article will expand on various topics.
What are Stocks?
A stock, also known as a share or equity, represents ownership in a company.
When you buy a stock, you’re buying a piece of the company’s profits and assets.
Here’s a really quick example that helps me understand this because to say a stock represents ownership is a bit vague for me.
I own Tesla stock and follow some educational people in the online community.
Jason DeBolt (a popular Tesla shareholder) did some calculations based on the amount of shares available and discovered that 100 shares = 1 second of production.
So if you own 6000 shares, this represents 1 minute of production per year.
Now imagine everything that goes on in the entire Tesla company for 1 minute. All the work that’s going on in all their factories around the world.
That is what you own per year. So the stock price might vary from day to day, but your ownership represents 1 minute of production per year (assuming you own 6000 shares).
I think that’s a pretty cool way to think about it.
This ownership comes with certain rights, such as voting in shareholder meetings and potentially receiving dividends, which are a share of the company’s profits.
How Do Stocks Work?
Let’s first quickly review why stocks even exist.
In the 17th century the first company issued stocks to the public.
So why did they do this?
By issuing stocks, a company gets money in return. They use this money to fund their growth and operations.
Today it all starts with an IPO (Initial Public Offering). This is the process of a private company going public. It’s when they offer shares to the public for the first time.
There are many reasons why a company “goes public”, but the main reason is to raise money.
When a company gets listed on the stock market for the first time, people can buy shares and the company receives the money. They can use this money to grow and expand the business.
How Does the Stock Market Work?
At the time of writing this, Tesla’s stock price is around $250. If you invested $1000 in Tesla at their IPO, you would have over $220,000.
The stock market is where shares of public companies such as Tesla can be bought and sold. People like you and me who are called retail investors can buy and sell stock, along with institutional investors (companies buying stock for their clients).
Remember stocks are investments. The stock market is where you can buy and sell these investments through various stock exchanges. When you buy and sell stock, you are buying and selling from other investors, not the actual company.
During Tesla’s IPO, its shares were listed on the Nasdaq.
The Nasdaq is a stock exchange where many tech companies list their shares.
Think of stock exchanges as a marketplace where stocks are bought and sold. There are several stock exchanges around the world:
| New York Stock Exchange (NYSE) | USA |
| Nasdaq | USA |
| Shanghai Stock Exchange | China |
| Hong Kong Stock Exchange | Hong Kong |
| Euronext | Europe |
| London Stock Exchange (LSE) | United Kingdom |
| Shenzhen Stock Exchange | China |
| Toronto Stock Exchange (TSX) | Canada |
| Bombay Stock Exchange (BSE) | India |
| National Stock Exchange (NSE) | India |
What about market indexes?
Market indexes are statistical measures that track the performance of a specific group of stocks.
So the Standard & Poor’s 500 Index (S&P 500) includes the 500 of the largest companies listed on stock exchanges in the U.S.
The Nasdaq Composite Index includes all the stocks listed on the Nasdaq stock exchange.
These indexes help you track the performance of various markets and segments.
Here are the main indexes:
- Dow Jones Industrial Average (DJIA)
- Standard & Poor’s 500 Index (S&P 500)
- Nasdaq Composite Index
- FTSE 100 Index
- Nikkei 225
- DAX (Deutscher Aktienindex)
- CAC 40 (Cotation Assistée en Continu)
- Shanghai Composite Index
- Hang Seng Index
- S&P/TSX Composite Index
In order for you to buy and sell shares of a company, you will trade through a brokerage firm, which acts as an intermediary in the stock market.
There are many different brokerage firms you can use. These days you can sign up with an online brokerage firm and do everything from your computer.
Here are 10 popular brokerage firms in the United States and Canada that you can use to buy and sell stocks:
Common brokerage firms in the United States:
| Charles Schwab | Known for its robust research tools and large selection of mutual funds. |
| Fidelity Investments | Offers a wide range of services including online trading, retirement planning, and wealth management. |
| TD Ameritrade | Known for its powerful trading platforms, extensive research, and comprehensive educational resources. |
| E*TRADE | Offers online brokerage services with a variety of investment choices and educational resources. |
| Robinhood | A mobile-first brokerage known for commission-free trades, primarily appealing to a younger, tech-savvy demographic. |
Common brokerage firms in Canada:
| TD Direct Investing | Part of TD Bank Group, offers online trading and investment services. |
| RBC Direct Investing | A subsidiary of the Royal Bank of Canada, offers various trading and investment services. |
| Questrade | A popular online brokerage offering low-cost trading, ETFs, and robo-advisor services. |
| BMO InvestorLine | Operated by the Bank of Montreal, offers online trading and investing services. |
| Wealthsimple Trade | Known for commission-free stock and ETF trading, appealing to a new generation of investors. |
I personally have an account with Questrade and I’m planning to open a new account with Interactive Brokers to do all my day trading with.
Once you sign up with a brokerage account, you simply transfer funds from your bank account, and you can buy stocks on various stock exchanges.
What About Stock Prices? How Do They Work?
Let’s review our Tesla example to understand what determines a stock price.
Here’s a boring definition:
The price of a stock is primarily determined by supply and demand dynamics in the market. This means that if more people want to buy a stock than sell it, the price goes up, and if more want to sell than buy, the price goes down. This pricing is also influenced by investor perceptions of the company’s future prospects, financial performance, and broader economic conditions. Stock prices are set through an auction process on exchanges, where the balance between buyers’ bids and sellers’ asks determines the final price.
This example will help make this clear:
Let’s continue using Tesla for this example.
When Tesla first went public, its stock price was significantly lower than it is today. As I mentioned above, at the time of writing, Tesla’s stock price stands at around $250. This remarkable increase in stock price over the years can be attributed to several factors.
As Tesla grew, developed new technologies, expanded its production capabilities, and reported increasing sales and profits, more investors wanted to buy its stock, seeing the company as valuable and having strong future prospects. This increased demand, coupled with a relatively fixed supply of shares, drove the stock price up.
Tesla’s innovative approach in the electric vehicle industry and its influence on the automotive market also played a critical role. As the company achieved various milestones and garnered positive attention, investor confidence grew, further fueling the demand for Tesla shares.
The stock market, where shares of companies like Tesla are traded, operates on these principles of supply and demand. As Tesla became more valuable as a company, the demand for its shares increased, leading to a rise in its stock price. This is a clear example of how a company’s growth and success can directly influence its stock price in the market over the long term.
Investing $1,000 in Tesla at its IPO, considering the stock’s substantial growth over the years, would have resulted in a portfolio valued at over $220,000 today. What do you think this will be in 2030?
This exemplifies the potential for significant returns in the stock market, especially when investing in companies that show promising growth and innovation.
But don’t forget, stocks don’t always go up. Just like they can go up, they can come crashing down, along with your potential profits.
Related Article:
Key Insights
- Stocks Represent Ownership: Owning a stock means holding a piece of a company’s profits and assets. Example: Owning Tesla stock equates to owning a fraction of the company’s production capacity.
- Historical Context of Stocks: The concept of issuing stocks started in the 17th century as a means for companies to raise funds for expansion and operation.
- The IPO Process: Initial Public Offerings (IPOs) mark the transition of a private company to a public one, allowing it to raise capital by offering shares to the public.
- Stock Market Dynamics: The stock market is a platform where shares of companies like Tesla are traded. It includes retail and institutional investors and is facilitated by various stock exchanges worldwide.
- Role of Stock Exchanges: Exchanges such as the NYSE, Nasdaq, and others serve as marketplaces for buying and selling stocks.
- Importance of Market Indexes: Indexes like the S&P 500 and Nasdaq Composite track the performance of a group of stocks, providing insights into market trends.
- Brokerage Firms as Intermediaries: Brokerage firms, both online and traditional, act as intermediaries for investors to buy and sell stocks.
- Stock Price Determination: The price of stocks like Tesla is determined by supply and demand, as well as factors like company performance and investor perception.
- Potential for High Returns: Investments in stocks have the potential for significant returns, as illustrated by the growth in Tesla’s stock value since its IPO.
- Risk of Decline: While stocks can offer high returns, they can also decrease in value, highlighting the importance of understanding market risks.
