Shares and Stock Market Basics

How does the stock market function?

The stock market is a combination of a swap meet, auction house, and retail mall.

As a swap meet or flea market, the stock market: Individual and institutional investors, such as hedge funds, pension plans, and investment banks, buy and sell various items on the stock market, such as public firms listed on stock exchanges.

The New York Stock Exchange (NYSE), Nasdaq Exchange, and OTC Markets are some of the most well-known stock exchanges. Companies that want to use their services to generate funds from investors must meet certain listing standards.

As an auction house, the stock exchange: The stock market's auction-style pricing method is another interesting feature. Unlike in a store, where each item has a fixed price, stock prices fluctuate constantly as buyers and sellers try to obtain a fair market price for a company's stock.

Stock prices are influenced by both internal and external influences. Internal factors, such as a company's earnings and growth potential, can have an impact on its stock price. Meanwhile, external factors such as the outcome of an impending election or investor sentiment on the economy's path might influence stock prices.

The stock market as a shopping mall: Finally, because it is a one-stop-shop, the stock market has a shopping mall feel to it. It's where all publicly traded corporations are housed, allowing investors to purchase and sell whatever publicly traded stock they want.

For a company's equity, stock exchanges serve as both primary and secondary markets. They help corporations to raise money and build their businesses by selling shares directly to the public through initial public offerings (IPOs).

When a company needs more money, it can issue repeated secondary offerings of its stock, as long as buyers are ready to buy. Meanwhile, exchanges provide liquidity to investors by allowing them to sell shares to one another.

Stock trading vs. long-term investing

We'd all like to become wealthy rapidly. The stock market, on the other hand, is neither a lottery nor a casino. While certain equities deliver large increases in a short period of time, they are outliers rather than the average.

As a result, novice investors should avoid stock trading or aggressively buying and selling stocks, particularly day trading, and instead concentrate on long-term buy-and-hold investing.

For a variety of reasons, long-term investing is preferable to stock trading, including:

• Positive returns are more likely: While the stock market has had down years, it has gone up in 40 of the last 50 years. Thus, even if you begin investing near the end of a long bull market run and experience a stomach-churning drop, simply holding for a few years will almost always result in a good outcome. In contrast, trading might result in a permanent loss of capital if an investor buys at the top and then gives up and sells at the bottom, locking in losses.

• Not missing out on even higher gains: One of the most common blunders made by new investors is selling too soon. They may miss out on substantially higher returns in the long run as a result of this. While it may be tempting to cash in after a 10% or even 100% gain, exceptional firms are more likely to continue providing winning returns.

• Stock sales are taxable unless they are conducted in a tax-deferred retirement account, such as an IRA. The capital gains tax rate for equities held long-term, which is more than a year, is either 0%, 10%, or 20%, depending on your income and tax band. Short-term capital gains taxes, on the other hand, are substantially higher because they correspond to an investor's regular income tax band, which runs from 10% to 37%. As a result, if an investor is trading in and out of stocks, taxes can eat up a considerable amount of their gains, especially for those in higher tax brackets.