Understanding how stocks and shares work is crucial to making informed decisions about your money.
Stocks and shares represent ownership in public companies, allowing you to own a small piece of a business and benefit from its successes.
When a company does well and profits increase, the value of its shares also rises, and when the company struggles, share prices drop.
By buying and selling at the right times, you have the potential to make money through the stock market.
However, there is also the possibility of losing money if share values decrease.
We will provide you with everything you need to know to understand stocks and shares to determine if investing in the stock market is right for your financial goals.
What Are Stocks and Shares?
Stocks and shares represent ownership in public companies and are bought and sold on stock exchanges. As an investor, you purchase shares to generate a return on your investment. There are two main ways to make money from shares:
- Dividends: Companies may pay out a portion of their profits to shareholders as dividends. The more shares you own, the larger your dividend payments can be. Some companies pay dividends regularly, while others may pay out dividends occasionally or not at all.
- Share price appreciation: If the company performs well, demand for its shares will rise. This causes the share price to increase, and the value of your investment goes up. You can generate a return by selling your shares at a higher price than you paid. Of course, share prices can also decrease if a company struggles, reducing the value of your investment.
To purchase shares, you must go through a stockbroker who can execute buy and sell orders on your behalf on a stock exchange. Stock exchanges, like the New York Stock Exchange or Nasdaq, are where company shares are listed and publicly traded.
How Do Companies Issue Stocks?
Companies issue stocks, also known as shares, to raise money from investors. By selling shares of ownership in the company, businesses can generate capital to fund operations, growth, and other business initiatives.
There are a few ways companies can issue stocks:
- Initial Public Offering (IPO): When a company first lists its shares on a public stock exchange, it conducts an IPO. This allows the general public to buy shares in the company for the first time. The company hires an investment bank to help determine the initial share price and facilitate the listing process.
- Follow-on Offering: After a company has already had an IPO and is publicly traded, it may issue additional shares in what is known as a follow-on offering. This generates extra capital from the sale of new shares. Existing shareholders may face a decrease in their ownership stake due to the new shares.
- Private Placement: Companies can also issue shares through a private placement, in which new shares are sold to select private investors like institutions. These shares are not listed on a public exchange. Companies may do a private placement to raise capital from accredited investors without going through an IPO.
- Rights Issue: Public companies sometimes offer new shares first to existing shareholders. This is known as a rights issue. Shareholders are given the right, but not the obligation, to buy new shares in proportion to their existing ownership stake. This helps companies raise capital while allowing current shareholders to avoid reductions if they participate.
When a company issues new shares, the total number of outstanding shares increases. This means existing shareholders own a smaller percentage of the company, known as dilution. Companies must balance raising sufficient capital through new share issues while limiting decreases for their existing owners.
Proper share issuance is crucial for companies to fund their business needs, but it requires careful management to keep shareholder interests in mind. With various options, companies can select the approach that suits their unique needs and situations.
How to Buy and Sell Stocks
To buy and sell stocks, you will open a brokerage account. This can be done through an online broker that allows you to buy and sell stocks electronically or through a traditional broker with physical branch locations.
Choosing a Brokerage Account
When choosing a brokerage, consider commissions, fees, investment options, and services offered. Brokerages often offer educational resources to help you learn.
Once you fund your brokerage account, you can begin buying stocks. Research to find companies you believe in and share what you want to own. When you’re ready to buy, log in to your brokerage account and enter the stock ticker symbol, number of shares, and type of order. The two most common order types are:
- Market orders: Execute immediately at the current market price. Use for highly liquid stocks.
- Limit orders: Only execute if the stock reaches your target price. Use it to try and get a lower price.
When it’s time to sell stocks, the process is similar. Log in to your brokerage, enter the stock ticker symbol for the number of shares, and select a sell market or limit order. The sale proceeds, less commissions or fees, will be deposited into your brokerage account in cash.
Using a brokerage account to buy and sell stocks allows you to invest in the companies and industries you believe in. However, there is risk involved, especially for beginners. Do thorough research, start with small amounts of money, and consider consulting a financial advisor to help guide you. With time and experience, you can become skilled at navigating the ups and downs of the stock market.
For Muslims, you can use apps like Musaffa to learn which stock is halal and which one is haram with our stock screener.
Understanding Stock Market Indexes
Understanding stock market indexes is key to navigating the market’s ups and downs and determining the economy’s overall health.
The Dow Jones Industrial Average
The Dow Jones Industrial Average (DJIA) is one of the most well-known stock market indexes. It tracks 30 large companies listed on US stock exchanges. The DJIA is a price-weighted index, meaning companies with a higher stock price have a greater influence on the overall index. The DJIA is a good indicator of how major blue-chip US companies perform.
The S&P 500
The S&P 500 index includes 500 large companies listed on US exchanges and covers about 80% of available market capitalization. It is a broader measure of large-cap US equities. The S&P 500 is a market-cap-weighted index, so companies with a higher market capitalization have a bigger impact. It is a benchmark for the overall US stock market and economy.
The Nasdaq Composite
The Nasdaq Composite Index tracks over 3,000 companies listed on the Nasdaq stock exchange, primarily technology and biotech companies. It is a broad measure of the Nasdaq stock market. The index is market-cap-weighted. Since it focuses on tech companies, the Nasdaq Composite is more volatile than the DJIA or S&P 500. It indicates the performance of growth stocks and innovation-focused companies.
Some indexes track sectors, industries, market caps, geographies, and investment styles. For example, the Russell 2000 tracks small-cap US stocks. The MSCI EAFE index follows large and mid-cap stocks in Europe, Australasia, and the Far East. Bond market indexes like the Bloomberg Barclays US Aggregate Bond Index track the overall US bond market.
Stock market indexes provide insight into the market’s sectors and segments. By understanding the different indexes, you can determine the overall market direction and see which areas are leading or falling behind. Indexes are also the basis for many ETFs and mutual funds that can be used to invest in the broad market or specific sectors.
Tips for Investing in Stocks and Shares
Do Your Research
Before investing in stocks and shares, understand how the stock market works. Read books, take a course, or do research online about different types of investments, market sectors, and financial metrics.
Become familiar with key terms like dividends, earnings per share, portfolio, risk tolerance, and diversification. Know the difference between growth and value stocks, and understand how the laws of supply and demand determine share prices. The more you learn, the better equipped you’ll be to make strategic investment decisions.
Choose a Brokerage Firm
Next, you’ll need to choose an online broker that allows you to buy and sell stocks. Compare different brokerages to find one that suits your needs and budget. Consider account minimums, trading commissions, investment options, tools, and resources.
Build a Diverse Portfolio
Don’t put all your eggs in one basket. A good portfolio contains a mix of stocks, funds, and other alternatives across different industries, company sizes, and risk levels.
As a general rule, allocate higher percentages to stocks when you are younger since you have more time to recover from market downturns. Increase lower-risk investment holdings as you get closer to retirement to balance risk. Review and rebalance your portfolio at least once a year to maintain your target allocations.
Monitor and Adjust
Once you purchase stocks and shares, monitor their performance and make changes as needed. Track stock prices daily and look for trends to see if it’s time to buy or sell. Review quarterly earnings reports and analyst ratings to determine if your invested companies are still sound.
If some of your holdings drop in value, you may need to rebalance by selling or purchasing more shares to bring your portfolio back to your original target allocations. Successful investing requires ongoing effort and diligence.
You now have a solid understanding of how stocks and shares operate in today’s market. While the concepts may seem complex, the core ideas are quite straightforward.
Companies issue shares to raise funds from investors in exchange for a stake in the business. Investors can then buy and sell these shares on an exchange to potentially generate a profit. By researching companies and market trends, you can make informed investment decisions and build a diverse portfolio to achieve your financial goals.
Although there is always a risk, the stock market has historically outpaced other investments over the long run.
With the right strategy and discipline, you can put this knowledge into action and gain valuable experience in investing.
Please visit our academy to read more about Islamic Finance-related topics.
Also, feel free to sign up for our free Halal stock screening service at musaffa.com
Disclaimer: Important information