Buying and selling stocks for investment is no longer the domain of the professional trader. Master the basics of trading first, then you'll be ready to research and manage your own investment portfolio.
What are stocks?
A stock is a type of security that reflects ownership in a publicly traded company. When companies need to raise large sums of money for business expansion or equipment purchases, they may choose to issue securities like stocks or bonds to the general public. Bonds are debt securities that work like a loan. Stocks are equity securities that can increase significantly in value if the company does well.
When you invest in stocks, you're taking a calculated risk that your investment will increase at a greater rate than the potential interest from conventional accounts. Before you begin trading stocks, be sure to carefully review Part 2 of this article, Risks and Rewards.
How to buy and sell stocks
To trade stocks, you must open and fund an account with either an in-person broker or an online firm like Ally Invest. With the former, you tell the broker the quantity of the specific stock you wish to purchase or sell. The broker executes the trade on your behalf, earning a commission that is generally several cents per share.
Online trading with Ally Invest empowers you to make the trades electronically. Commission fees can be significantly lower when you trade online.
Buying a company's stock means you are a shareholder and entitled to a portion of the company's earnings and assets. If the stock is publicly traded, there are usually many shareholders. When the company turns a profit, you share in the benefits, often in the form of quarterly dividends paid to you. If the company doesn't pay a dividend, any profits are reinvested in the company's business. Theoretically, this increases the stock price. With a non-dividend paying company, your share of the profits should be reflected in an appreciation (increase) of your principal investment.
Trading stocks in primary and secondary markets
When a stock is first issued to the general public, it's released through an initial public offering (IPO) or primary market. The company issuing the stock enlists an underwriting firm to help determine their optimal initial offering price and timing for bringing it to market. Then, the stock is offered for sale with the underwriting firm acting as middleman.
Usually, an IPO will be conducted by a newer company that's undergoing an expansion phase, but they can be issued by older privately held firms that want to be traded publicly. Be sure to read the company prospectus before purchasing any stock _ particularly if you're considering an IPO.
When the stock begins to trade on stock exchanges between individual investors or institutions, this is known as active trading in the secondary market. A company may repurchase shares sold during the IPO in the open market to drive the company's stock price higher in the secondary market.