What are Stocks?
Most people think stocks are pieces of paper being traded off for a profit, when in fact stocks are much more than that. Stocks are pieces of OWNERSHIP in a company.
Example: if you decide to start a business today with a friend and you put $60 dollars in and your friend puts in the other $40 what would be the percentage in ownership of the company? Of course you would own 60% and your friend 40% and you would own 60 shares of stock and your friend 40 shares of stock (out of 100) from your private company. This same happens with stocks when they go public, more than often companies need to raise more money in order to buy new equipment or expand their business. They have found raising money from the public in order to fulfill their needs has become the most effective way to reach their goals.The next step for them is to sell part of their ownership to the public in order to raise the amount needed. The portion they sell is divided into shares of stock or pieces of ownership in the company.
[pullquote]Stocks are pieces of OWNERSHIP in a company.[/pullquote]When you buy a stock, you become a business owner nothing more than that. That is why is so important to study and do your homework before you buy any stock. You just don’t buy a business because everybody says its a good idea, you prepare and analyze the market before you jump in with two feet on the water.
Over the time we own our shares of stock the value will increase or decrease, this occurs mainly because the underlying business we own has increased its success. In other words the better a business does the more your percentage of ownership will be worth increasing in value.
Stocks are then classified into indexes which help track a certain part of the stock market. There are thousands of stocks listed in the U.S. a stock index helps you break through the clutter and gives you an average of how a particular section of the market is doing. The most popular index is the almighty DOW JONES (you probably have heard of this one already). The S&P500, and the Nasdaq are other popular indexes.
DOW JONES: This index measures the performance of the 30 largest industrial companies in the U.S. this usually help investors see how the industrial side of the U.S. is performing in general.
S&P 500: The Standard and Poor’s 500 index is also very popular it includes 500 companies handpicked by the Standard and Poor’s Committee designated to reflect how the market is doing in general.
Nasdaq: Last but not least the Nasdaq that stands for (National Association of Securities Dealers Automated Quotations System) this index doesn’t capture media attention as the other two do, but is where most of technology stocks are traded. Microsoft, Cisco, Facebook amongst other big names are traded in this Index.
Let’s say you are interested in knowing how the U.S. in general is doing. You will then check how the DOW has been performing, as it contains the biggest industrial names that fuel our country. The same goes for the tech sector, you will then check the NASDAQ, mainly because it lists the biggest tech companies and can serve as a general guideline for how the market is reacting or how optimistic it feels about technology.
To test the teachings in this lesson your homework will be to observe how much an index has increased or decreased (usually when an Index rises or falls 1% or more it will give you a better observation), and then check how the individual stocks pertaining to this index reacted during the day.
For example if the NASDAQ rises 1% we will expect that companies such as Facebook (FB) and Apple (AAPL) increased as well .
Watch this short cartoon video on “How the Stock Market Works” (Recommended)