WHAT IS STOCK TRADING AND HOW DOES IT WORK?

When starting out in the world of trading and investing, you may have found yourself wondering: “What’s the stock market?” The stock market is an auction-based market that involves the buying and selling of individual shares as well as groups of shares. Stocks are often referred to as equities as the buyer is receiving partial ownership of an individual company or group of companies. Stock prices are generally more volatile than other assets such as currencies or bonds. Stocks, which are also known as shares, are popular financial instruments because they provide returns that are generally more robust than bonds over an extended period. There are several strategies that you can use to trade stocks to generate potentially robust returns.

What is a stock?

A stock or share can be defined as partial ownership of a company. When companies are looking to raise capital using the public markets, they will offer equity to the public in the form of individual shares. If you multiply the total outstanding shares of a company by the price, you can calculate the value of a company. Some shares offer voting rights, where you can weigh in on issues that are in front of the company’s board of directors. Some stocks receive dividends which is a portion of the profits of the company and is issued as payment generally on a quarterly basis.

What is a stock index?

A stock index is an index that is calculated using the price of several different companies that are in the index. For example, the S&P 500 generates an index by calculating the value of the stocks of the 500 largest corporations by market capitalization. These stocks are listed on the New York Stock Exchange or Nasdaq Composite.

How does stock trading work?

Stock trading is the process of buying and selling individual shares or groups of shares called indices. Some view stock trading as buying and holding the shares forever. Others see stock trading as a short-term endeavour where they are attempting to capture gains based on the volatile movements in stock prices.

Why is stock trading popular?

Stock trading is very popular because it is easy to understand and readily accessible to most individuals. Stocks are used for both long-term and short-term investments. Stock trading accounts are accessible to individuals in many countries. In many developed countries, the local news will report on the benchmark stock indices such as the Dow Industrials, the DAX, the FTSE, and the Nikkei.

Stock markets are often viewed as a benchmark for the strength of a country or union. When stock prices are rising, the discounted future cash flows of a country are expected to increase, which is a sign of future strong economic growth.

Why do stock prices change all the time?

Stocks fluctuate constantly as buyers and sellers speculate on the future direction of shares. Shares are generally active and liquid during a country’s business hours, but indices can be active around the clock. For example, the S&P 500 index is liquid 24-hours a day, 6-days a week.

What types of strategies are used to trade stocks?

There are several strategies that are used to trade stocks. Some investors buy and hold stocks, attempting to generate long-term capital gains as well as dividends. Stock prices over the long term generally outperform other assets. For example, the average annual return of the S&P 500 index since it became an index of 500 stocks in 1957 is 8% a year.

This means that every 9 years, your money would double. This compares to an average annual return of treasury bonds of approximately 5%. When you buy and hold stocks, your goal should be to receive a compounded return as well as dividends.

Many market pundits call this style of trading, investing in stocks. There are several other trading strategies that are used to capitalize on the movement in stock prices. This includes fundamental analysis that targets the performance of a company, as well as technical analysis that evaluates past price action.

What moves the price of a stock?

Stock prices fluctuate based on several factors. A share can have a different value minute by minute as traders attempt to find the fair value of a stock. One theory is that the price of a stock is equal to the future discounted cash flows that a company produces. Each company reports its earnings and revenues as well as future guidance on a regular schedule. Most public companies report financial results quarterly. The value of a stock is a multiple of the earnings it produces per share. When a company reports its earnings, it reports the total profits as well as its profits per share. Analysts will then attempt to determine the growth in those earnings moving forward to determine the multiple that a company should receive.

Ahead of each earnings release, analysts forecast what a company is likely to report. If the earnings, revenues, and guidance are better than expected, a stock price will likely rise. If financial results are worse than expected, a stock price is likely to fall.

Stock prices are also driven by technical analysis (the study of past price action) which includes trend trading, momentum, and reversion to the mean. Many traders use the combination of technical analysis and fundamental analysis to determine if they will buy or sell a stock.

Summary

The stock market fluctuates constantly as investors buy and sell individual shares as well as groups of shares. Stock prices are generally more volatile than other assets such as currencies or bonds, making them a popular asset to day-trade. Stocks, which are also known as shares, are popular financial instruments because they provide returns that are generally more robust than bonds over an extended period. There are several strategies that you can use to trade stocks and generate robust returns, including buy and hold strategies as well as short-term momentum strategies. Some stocks produce dividends while others provide voting rights. Stocks are an attractive investment as they generally provide a gauge of the health of a country’s economy. Interested in stock trading online? Open a live account with One Financial Markets today.

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This article may contain opinions and is not advice or a recommendation to buy, sell or hold any investment. No representation or warranty is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however we have put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing.

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