Welcome to the world of stocks

Everybody knows the old maxim “buy low, sell high,” and we all hear rumors around the water cooler about stocks that are poised to take off. Some people think that’s all you need to know to make a killing in the stock market.

Those people are wrong.

Before you begin to invest in stocks or actively trade them, it’s crucial for you to understand exactly what a stock is and the fundamentals of how the stock market works. After all, you’re looking to put your money on the line and you should be informed before taking that first step. A stock is a type of security reflecting ownership in a publicly traded company.

Included here are important items to know before plunking down money for that first investment or initial trade, including: what it means to own stock; a comparison of stocks to bonds and a list of potential risks and rewards; an explanation of how stocks are bought and sold in the primary and secondary marketplaces; a discussion of the rights and protections of stockholders; a comparison of common and preferred stock; and insight into the NYSE and NASDAQ markets. Last, but certainly not least, you’ll learn about two major forces on stock prices — supply and demand and quarterly earnings reports. All of this is essential knowledge for any aspiring trader or investor.

Stock and bonds: How companies raise money

As companies evolve over time, sometimes they need to raise capital in order to expand operations, buy new equipment, build a new factory or office building, and myriad other purposes. For smaller endeavors, it may be possible to borrow money from a bank to cover expenses. When very large sums are needed, however, companies may instead decide to issue securities to the general public.

One way to go about this is to borrow money by issuing “debt securities” like bonds. When corporations sell bonds, they’re borrowing money from the institutions and members of the public who buy them. In return for the loan, bond buyers expect to receive interest payments and then receive the full face value of the bond at a specified date in the future.

However, if a company does not wish to be saddled with interest payments to creditors and face repayment of the debt on a specified date, they may instead choose to issue “equity securities” like stock in order to raise the money they need.

Risks and rewards of stocks vs. bonds

When you own a stock, nothing is guaranteed. If the firm goes bankrupt, you can potentially lose your entire investment. There may be nothing left over for you as a stockholder once the banks and bondholders have been paid off during liquidation – stockholders claim lower priority in a bankruptcy filing than creditors.

On the other hand, if the company does well, you may stand to gain much more than bondholders. Not only might you receive dividends if the company is profitable, the value of the stock itself may also increase over time — sometimes with spectacular results. Although bondholders are typically exposed to less risk, they only stand to gain interest payments over time, which generally is less than potential gains from stocks.

When investing in stocks, your objective is to take calculated risks so that your assets will appreciate at a rate greater than potential interest payments. When investing in bonds, the objective is to preserve your assets at lower risk while generating income from interest payments over time.

Differences between stocks and bonds