How does stock trading work?

Companies sell shares in order to raise money and enable their growth. When you buy these shares, you own stock or equity which effectively means that you own a fraction of the company. As a shareholder, you may be entitled to an annual dividend, which is a slice of the company’s earnings, and you can also profit from selling shares when they increase in value.

Stock trading isn’t new. The Dutch East India Company was the first to issue shares in the early 17th century and stock trading is considered one of the most profitable markets, provided you know what you’re doing, and you invest with a long-term view.

So how do I succeed in online stock trading?

The easy answer is that you find the best online platforms for stock trading, you open an account with one of them and you start buying shares. But, if you want to succeed, there are a few questions you need to consider, starting with which company you want to invest in. Stock prices fluctuate depending on a company’s financial wellbeing and performance, the sector it operates in, as well as the overall state of the economy. Remember that this is a longer-term game: you can buy stock not because of where a company is now but because of where you see it going in the next few years.

The second question to ask yourself is whether you’re interested in dividends . Some companies pay them out every year, which means a steady stream of income for you, whereas other companies don’t pay dividends because they reinvest in growth. So, even though you miss out on the annual pay check, you could make a lot more money in the future when the share price increases. Many investors take the re-investing approach themselves by throwing dividends back into their trading pot.

Then as you become more experienced in stock trading, you will start to appreciate the nuances of the market. You can choose between common stock, which comes with a voting right for shareholders’ meetings, and preferred stock which gives you a higher claim on assets but without the voting. You can even start exploring the various ratios that help analyse the value of a stock , e.g. earnings per share (eps), price to earnings (p/e) or dividend yield.

Finally, bear in mind that there are other financial products, called derivatives, which allow you to trade on a stock’s price change without owning the actual stock. There are the Contracts for Difference (CDFs) which we’ll discuss in another lesson.

Bitesize basics
  • Companies sell shares to raise money in order to expand. Traders buy shares in order to benefit from a future increase in value.
  • When you own stock in a company, you may be eligible for an annual dividend, i.e. a fraction of the company’s profit. However, some companies don’t pay dividends, either because they’re still new or because they re-invest earnings to accelerate growth.
  • Stock prices fluctuate depending on a company’s performance, the overall outlook of the sector of even the state of the national economy.
  • Stock trading is the most profitable market, provided you take a longer-term approach.

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